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Cost of Capital and Pro Forma Balance Sheet

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 Cap

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?

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?

We won't do your homework for you on this site. Normally if you show that you are trying to solve the problem on your own and got stuck somewhere someone will help you to the next step.

We wont do your homework for you on this site. Normally if you show that you are trying to solve the problem on your own and got stuck somewhere someone will help you to the next step.


Thanks