Finance problem: Weighted average cost of capital.
The financial manager of a firm determines the following
schedules of cost of debt and cost of equity for various combinations of debt
financing: Find the WACC.
1.Debt/Assets After-Tax
Cost of Debt Cost of Equity WACC
0% 4% 8%
10% 4% 8%
20% 4% 8%
30% 5% 8%
40% 6% 10%
50% 8% 12%
60% 10% 14%
70% 12% 16%
2. Find the optimal capital structure (that is, optimal
combination of debt and equity financing).
3. Why does the cost of capital initially decline as the
firm substitutes debt for equity financing?
4. Why will the coat of funds eventually rise as the firm
becomes more financially t as leveraged?
5. Why is debt financing more common than financing with
preferred stock? If interest were not a tax-deductible expense, what effect
would that have on the firm’s cost of capital? Why?
