eBook Problem 21-03 A firm’s current balance sheet is as follows: Assets $ 150 Debt $ 30 Equity $ 120 What is the firm’s weighted-average cost of capital at various combinations of debt and equity,...

Problem 21-03

A firm’s current balance sheet is as follows:

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	%	15	%	%
   10		8		15		%
   20		9		15		%
   30		9		15		%
   40		11		16		%
   50		13		16		%
   60		15		18		%

   
   

   
   



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	$	150		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

   
   


5. 
   

   riskier. This causes the interest rate to  and the cost of equity to  . These changes in

   
   


6. 
   

   the cost of debt and equity cause the cost of capital to  .