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Computation of weighted average cost of capital
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
30
13
40
9
14
50
15
60
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?
$?
c. As a firm initially substitutes debt for equity financing, what happens to the cost of capital, and why?
If a firm uses too much debt financing, why does the cost of capital rise
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