How does the cost of capital of the firm depends on the firm’s leverage ratio?
Cost of the capital of the firm is the weighted average cost of capital of debt and equity (and preferred stock)
Weight of debt*Post tax cost of debt + Weight of common stock * cost of common stock
To compute the weighted average cost of capital we have to find the weight of the each source of the capital . Weight can be market value based on book value based (Market value based weight is preferred).
Therefore if the debt weight change it will change the weight of equity in the overall capital structure.
Firm leverage ratio denote the proportion of the debt in the total capital structure. Leverage ratio like debt-equity is nothing but also impact the weight of the source of capital and therefore also the cost of capita.
How does the cost of capital of the firm depends on the firm’s leverage ratio?
How does the cost of capital of the firm depends on the firm’s leverage ratio? If the cost of capital of equity goes up and the cost of capital of debt goes up, and the firm consists only of debt and equity, does the capital of the firm goes up?
true or false: If the modigliani miller hypothesis holds, the firms cost of capital depends on how close is to the firms optimal leverage.
The world is risk neutral and interest rates are 20%. With probability ¼, your firm will be worth $60 next year. With probability ¾, it will be worth $100. What interest rate do you have to promise to raise $70 in debt today? In a perfect world, if the firm value is $76 under the debt-laden capital structure (say $70+$6), but the managers chose the $75 capital structure (say, all equity), what would you do? How does the cost of...
Question 1 Does financial leverage affect the profitability of a firm? Discuss your argument in the context of profitability ratios and a firm’s earning power. A firm has an EBIT of $35,000. It is currently an all equity firm has 9,000 shares of stock outstanding at a market price of $45 a share. The firm has decided to leverage its operations by issuing $120,000 of debt at an interest rate of 9.5 percent. This new debt will be used to...
2. In the context of a firm’s capital structure, when does a firm has an incentive to (i) take large risks and (ii) make underinvestment? Explain the mechanism/process.
A levered firm’s cost of equity capital is 15%. The firm has a market value of equity of $15 million and $5 million in outstanding debt at an interest rate of 5%. The corporate tax rate is 35%. What is the firm’s WACC?
Roger, Inc., has a debt-equity ratio of 2.85. The firm’s weighted average cost of capital is 10 percent and its pretax cost of debt is 6 percent. The tax rate is 24 percent. a. What is the company’s cost of equity capital? b. What is the company’s unlevered cost of equity capital? c. What would the company’s weighted average cost of capital be if the company's debt-equity ratio were .25 and 1.85?
true or false: under modigliani-miller , the value of the firm is independent of its capital structures, but the weighted average cost of capital still depends on the capital structures.
Dickson, Inc., has a debt-equity ratio of 2.4. The firm’s weighted average cost of capital is 9 percent and its pretax cost of debt is 7 percent. The tax rate is 25 percent. a. What is the company’s cost of equity capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. What is the company’s unlevered cost of equity capital? (Do not round intermediate calculations and enter your answer...
Dickson, Inc., has a debt-equity ratio of 2.5. The firm’s weighted average cost of capital is 11 percent and its pretax cost of debt is 9 percent. The tax rate is 22 percent. a. What is the company’s cost of equity capital? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. What is the company’s unlevered cost of equity capital? (Do not round intermediate calculations and enter your...