Current Balance Sheet
Assets $100 Debt $10
Equity $90
| Debt/Assets |
After-Tax Cost of Debt |
Cost of Equity |
Cost of Capital |
| 0% |
8% |
12% |
? |
| 10% |
8% |
12% |
? |
| 20% |
8% |
12% |
? |
| 30% |
8% |
13% |
? |
| 40% |
9% |
14% |
? |
| 50% |
10% |
15% |
? |
| 60% |
12% |
16% |
? |
What is the firm's weighted-average cost of capital at various combinations of debt and equity, given the above information?
Cost of capita (k) = (weight) (cost of dept) + (weight) (cost of equity)
Construct a pro forma balance sheet that indicated the firms optimal capital structure.
Compare this balance sheet with the firm's current balance sheet. What course of action should the firm take?
Assets $100 Debt $ ?
Equity $ ?
As a firm initially substitues debt for equity what happens to the cost of capital, and why?
If a firm uses too much debt financing, why does the cost of capital rise?