FIN 370 Week 5 A firm’s current balance sheet is as follows: a. What is the firm’s weighted-average cost of

FIN 370 Week 5 A firm’s current balance sheet is as follows: a. What is the firm’s weighted-average cost of capital

 

Basic Finance: An Introduction to Financial Institutions, Investments, and Management by Mayo Axia College of University of Phoenix (UoP)

FIN 370 Week 5 Text Problem 3 A firm’s current balance sheet is as follows:

A firm’s current balance sheet is as follows:
Assets $100 Debt $10

Equity $90

a. What is the firm’s weighted-average cost of capital at various combinations of debt and equity; given the following information? Show work.

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% ?

b. Construct a pro forma balance sheet that indicates the firm’s optimal capital structure. Compare this balance sheet with the firm’s current balance sheet. What course of action should the firm take?

Assets $100 Debt $? Equity $?

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

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

 

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