Final Exam - Lecture 15/Chap 10 *Cost of debt is always...

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Lecture 15/Chap 10 **Cost of debt is always less than the cost of equity for and individual firm -thus as the Weight of Debt goes up – WACC goes down (Inversely related) -Why is 100% Debt not practical? -MORE DEBT==MORE RISK -Cost of debt not constant- As D/A goes up-lenders in riskier position-want higher return -Cost of Equity not constant- As D/A up- owner of stock risk increase- want higher return Business Risk - The risk a firm would have with 0 debt **The risk inherent in the firms area of operation Financial Risk - An increase in risk over the firms business risk—due to use of debt Optimal Capital Structure - The % of debt, preferred stock, and equity that will maximize shareholder wealth. **Optimal Cap Structure = D/E ratio that minimizes firms cost of capital** --Cap structure -*More debt immediately increases risk to shareholder* -WACC declines as small amounts of debt are added to 100% equity financed firm. The increase in cost of equity is not enough to offset advantages of using debt. **The minimum WACC=Optimal Cap Structure**--lowest point on WACC graph -WACC rises at D/A after firms minimum WACC—Beyond optimal cap structure financial risk increases to the point that using extra debt cause WACC to
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This document was uploaded on 10/26/2011 for the course BLS 342 at Miami University.

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Final Exam - Lecture 15/Chap 10 *Cost of debt is always...

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