View the step-by-step solution to:

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?
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?

This question was asked on May 08, 2010.

Recently Asked Questions

Why Join Course Hero?

Course Hero has all the homework and study help you need to succeed! We’ve got course-specific notes, study guides, and practice tests along with expert tutors and customizable flashcards—available anywhere, anytime.


Educational Resources
  • -

    Study Documents

    Find the best study resources around, tagged to your specific courses. Share your own to gain free Course Hero access or to earn money with our Marketplace.

    Browse Documents
  • -

    Question & Answers

    Get one-on-one homework help from our expert tutors—available online 24/7. Ask your own questions or browse existing Q&A threads. Satisfaction guaranteed!

    Ask a Question
  • -


    Browse existing sets or create your own using our digital flashcard system. A simple yet effective studying tool to help you earn the grade that you want!

    Browse Flashcards