5. The relationship between a firm's capital structure and other company attributes As a firm takes on more debt, its probability of bankruptcy increases . Other factors held constant, a firm whose earnings are relatively volatile faces a lower chance of bankruptcy. Therefore, when other factors are held constant, a firm whose earnings are relatively volatile should use debt than a more stable firm. When bankruptcy costs become more important, they increase the tax benefits of debt. General Forge and Foundry Corporation currently has no debt in its capital structure, but it is considering using some debt and reducing its outstanding equity. The firm's unlevered beta is 1.2, and its cost of equity is 12.40%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 12.40%. The risk-free rate of interest (RF) is 4%, and the market risk premium (RPM) is 7%. General Forge's marginal tax rate is 25%. General Forge is examining how different levels of debt will affect its costs of debt and equity, as well as its WACC. The firm has collected the financial information that follows to analyze its weighted average cost of capital (WACC). Complete the following table. D/Cap Ratio 0.0 0.2 0.6 0.8 E/Cap Ratio 1.0 0.8 0.6 0.4 0.2 D/E Ratio 0.00 0.25 0.67 1.50 Bond Rating A BBB BB 0 с Before-Tax Cost of Debt (ra) 7.2% 7.7% 8.9% 11.9% Levered Beta (b) 1.2 1.800 2.550 4.800 Cost of Equity ( 12.40% 13.975% 16.600% 37.600% WACC 12.40% 12.260% 12.745%
5. The relationship between a firm's capital structure and other company attributes As a firm takes on more debt, its probability of bankruptcy increases . Other factors held constant, a firm whose earnings are relatively volatile faces a lower chance of bankruptcy. Therefore, when other factors are held constant, a firm whose earnings are relatively volatile should use debt than a more stable firm. When bankruptcy costs become more important, they increase the tax benefits of debt. General Forge and Foundry Corporation currently has no debt in its capital structure, but it is considering using some debt and reducing its outstanding equity. The firm's unlevered beta is 1.2, and its cost of equity is 12.40%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 12.40%. The risk-free rate of interest (RF) is 4%, and the market risk premium (RPM) is 7%. General Forge's marginal tax rate is 25%. General Forge is examining how different levels of debt will affect its costs of debt and equity, as well as its WACC. The firm has collected the financial information that follows to analyze its weighted average cost of capital (WACC). Complete the following table. D/Cap Ratio 0.0 0.2 0.6 0.8 E/Cap Ratio 1.0 0.8 0.6 0.4 0.2 D/E Ratio 0.00 0.25 0.67 1.50 Bond Rating A BBB BB 0 с Before-Tax Cost of Debt (ra) 7.2% 7.7% 8.9% 11.9% Levered Beta (b) 1.2 1.800 2.550 4.800 Cost of Equity ( 12.40% 13.975% 16.600% 37.600% WACC 12.40% 12.260% 12.745%
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:5. The relationship between a firm's capital structure and other company attributes
As a firm takes on more debt, its probability of bankruptcy increases Other factors held constant, a firm whose earnings are relatively volatile
faces a lower chance of bankruptcy. Therefore, when other factors are held constant, a firm whose earnings are relatively volatile should use
debt than a more stable firm. When bankruptcy costs become more important, they increase the tax benefits of debt.
General Forge and Foundry Corporation currently has no debt in its capital structure, but it is considering using some debt and reducing its
outstanding equity. The firm's unlevered beta is 1.2, and its cost of equity is 12.40%. Because the firm has no debt in its capital structure, its
weighted average cost of capital (WACC) also equals 12.40%. The risk-free rate of interest (TRF) is 4%, and the market risk premium (RPM) is 7%.
General Forge's marginal tax rate is 25%.
General Forge is examining how different levels of debt will affect its costs of debt and equity, as well as its WACC. The firm has collected the financial
information that follows to analyze its weighted average cost of capital (WACC). Complete the following table.
D/Cap
Ratio
0.0
0.2
0.4
0.6
0.8
E/Cap
Ratio
1.0
0.8
0.6
0.4
0.2
D/E Ratio
0.00
0.25
0.67
1.50
Bond
Rating
A
BBB
ВВ
с
Before-Tax Cost of
Debt (ra)
-
7.2%
7.7%
8.9%
11.9%
Levered Beta
(b)
1.2
1.800
2.550
4.800
Cost of Equity (
IS)
12.40%
13.975%
16.600%
37.600%
WACC
12.40%
12.260%
12.745%
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