Task: Individual Assignment – Weighted Average Cost of Capital
Be sure to cite any references you use to solve these questions.
Problem 1. The after-tax cost of debt and the cost of equity as follows for a firm at various percentages of debt in its capital structure. Calculate the firm’s weighted average cost of capital at each combination of debt and equity:
|
Debt / Assets
|
After-Tax Cost of Debt
|
Cost of Equity
|
Weighted Average Cost of Capital
|
|
0%
|
6%
|
10%
|
?
|
|
10%
|
6%
|
10%
|
?
|
|
20%
|
7%
|
10%
|
?
|
|
30%
|
8%
|
11%
|
?
|
|
40%
|
9%
|
13%
|
?
|
|
50%
|
10%
|
14%
|
?
|
|
60%
|
12%
|
16%
|
?
|
Problem 2. A firm’s current balance sheet is as follows:
|
Assets
|
$100,000
|
|
Debt
|
$10,000
|
|
|
|
|
Equity
|
$90,000
|
Construct a pro forma balance sheet that indicates the firm’s optimal capital structure. Compare this balance sheet with the firm’s current balance sheet. What course of action should the firm take?
Problem 3. Explain what happens to a firm’s weighted average cost of capital when there is no debt, when they first introduce some debt into the capital structure, and as the firm continues to increase the percentage of debt in the capital structure.