Sunday, June 20, 2010

A firm’s current balance sheet is as follows What is the firm’s weighted-average cost of capital

FIN 370

Axia College of University of Phoenix (UoP)

Basic Finance: An Introduction to Financial Institutions, Investments, and Management by Mayo

FIN 370 Week 5

FIN 370 Week Five (Week 5) Individual Assignments

INDIVIDUAL ASSIGNMENTS
1. Read the materials listed on for Week Five.
2. Prepare a response to problem 3 located in Chapter 21 of the Basic Finance: An Introduction to Financial Institutions, Investments, and Management text by Mayo.

Text Problem 3 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?

Click here for the SOLUTION