The board of directors of Hamilton health plan is considering the following alternative financial structures:
A) 30% debt 70%equity B) 40% debt 60%equity C) 50% debt 50%equity.
The cost of debt is expected to change between 8% and 12% over the range of percentages being considered. Stocks similar to Hamilton are returning dividends and growth yield rates of 18%. The return on high-grade commercial paper is currently 10% but is expected to decline over the next few years.
Compute the cost of capital for the three alternatives. Which structure would you recommend to the directors and why?. What additional information, if any would you like to have before making your recommendation?