During a meeting, your co-worker suggested that the firm you work for should issue debt to lower
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Question:
During a meeting, your co-worker suggested that the firm you work for should issue debt to lower its overall cost of capital.The firm is currently all-equity and has a 35% tax rate.Your co-worker says that the firm's current cost of capital is 10%, and debt is available at 8% pre-tax, so if the firm issues 50% debt and uses the money to buy back 50% of the shares outstanding (and ends up with 50% debt and 50% equity), they can lower the firm's cost of capital from the 10% current cost down to 7.6%, which is (0.5 x 10%) + (0.5 x 8% x (1-35%)).Is your co-worker correct?Briefly explain why or why not.
Related Book For
Foundations of Financial Management
ISBN: 978-1259024979
10th Canadian edition
Authors: Stanley Block, Geoffrey Hirt, Bartley Danielsen, Doug Short, Michael Perretta
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