“Increasing financial leverage increases both the cost of debt (rdebt) and the cost of equity (requity). So the overall cost of capital cannot stay constant.” This problem is designed to show that the speaker is confused. Buggins Inc. is financed equally by debt and equity, each with a market value of $1 million. The cost of debt is 5%, and the cost of equity is 10%. The company now makes a further $250,000 issue of debt and uses the proceeds to repurchase equity. This causes the cost of debt to rise to 6% and the cost of equity to rise to 12%. Assume the firm pays no taxes. a. After the debt issue, what percent of the firm is financed with debt? (Do not round intermediate calculations. Enter your answer as a whole percent.) b. After the debt issue, what percent of the firm is financed with equity? (Do not round intermediate calculations. Enter your answer as a whole percent.) c. What is the overall cost of capital? (Enter your answer as a percent rounded to 1 decimal place.)
“Increasing financial leverage increases both the cost of debt (rdebt) and the
a. After the debt issue, what percent of the firm is financed with debt? (Do not round intermediate calculations. Enter your answer as a whole percent.)
b. After the debt issue, what percent of the firm is financed with equity? (Do not round intermediate calculations. Enter your answer as a whole percent.)
c. What is the overall cost of capital? (Enter your answer as a percent rounded to 1 decimal place.)
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