A firm’s current balance sheet is as follows: Assets $ 110   Debt $ 22         Equity $ 88 What is the firm’s weighted-average cost of capital at various combinations of debt and equity, given the following information? Round your answers to one decimal place.   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     %   Construct a pro forma balance sheet that indicates the firm’s optimal capital structure. Choose the best structure from the options analyzed in part a. Compare this balance sheet with the firm’s current balance sheet. Round your answers to the nearest dollar.   Assets $ 110   Debt   $           Equity   $     What course of action should the firm take? Round your answer to the nearest whole number. Since the firm is currently using   % debt financing, it  at its optimal capital structure and  As a firm initially substitutes debt for equity financing, what happens to the cost of capital? The cost of capital initially  If a firm uses too much debt financing, why does the cost of capital rise? If a firm uses too much debt financing, the firm becomes  financially leveraged and riskier. This causes the interest rate to  and the cost of equity to  . These changes in the cost of debt and equity cause the cost of capital to  .

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
icon
Related questions
Question

A firm’s current balance sheet is as follows:

Assets $ 110   Debt $ 22
        Equity $ 88
  1. What is the firm’s weighted-average cost of capital at various combinations of debt and equity, given the following information? Round your answers to one decimal place.

     

    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     %

     

  2. Construct a pro forma balance sheet that indicates the firm’s optimal capital structure. Choose the best structure from the options analyzed in part a. Compare this balance sheet with the firm’s current balance sheet. Round your answers to the nearest dollar.

     

    Assets $ 110   Debt   $  
            Equity   $  

     

    What course of action should the firm take? Round your answer to the nearest whole number.

    Since the firm is currently using   % debt financing, it  at its optimal capital structure and 

  3. As a firm initially substitutes debt for equity financing, what happens to the cost of capital?

    The cost of capital initially 

  4. If a firm uses too much debt financing, why does the cost of capital rise?

    If a firm uses too much debt financing, the firm becomes  financially leveraged and riskier. This causes the interest rate to  and the cost of equity to  . These changes in the cost of debt and equity cause the cost of capital to  .

Expert Solution
steps

Step by step

Solved in 2 steps

Blurred answer
Similar questions
  • SEE MORE QUESTIONS
Recommended textbooks for you
Essentials Of Investments
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
FUNDAMENTALS OF CORPORATE FINANCE
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:
9781260013962
Author:
BREALEY
Publisher:
RENT MCG
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
Foundations Of Finance
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education