Question

General Forge and Foundry Corporation currently has no debt in its capital structure, but it is considering using some debt and reducing its outstanding equity. The firm’s unlevered beta is 1.25, and its cost of equity is 13.00%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 13.00%. The risk-free rate of interest ( rRF ) is 3%, and the market risk premium ( RPM ) is 8%. General Forge’s marginal tax rate is 25%. General Forge is examining how different levels of debt will affect its costs of debt and equity, as well as its WACC. The firm has collected the financial information that follows to analyze its weighted average cost of capital (WACC).

Complete the following table

Cost of Equity E/Cap Ratio Bond Rating Before-Tax Cost of Debt (d) fore-Tax Cose D/Cap Ratio 0.0 0.2 WACC D/E Ratio 0.00 Levered Beta (b) 1.25 1.0 nating 13.00% 13.00% 0.8 0.25 A 8.4% 13.158% 14.872% 18.000% 0.4 BBB 8.9% 1.875 0.6 0.4 0.67 1.50 0.6 вв 11.1% 2.656 14.694% 0.8 14.3% 5.000 43.000%

Answer 1

A B C D F G H 1 D/Cap E/Cap D/E Bond Rating Before tax cost of debt Levered beta Cost of equity WACC 0 1 0 1.25 13.00000% 13.000% 0.2 0.8 0.25 A 8.40% 1.484 14.87200% 13.158% 4 0.4 0.6 0.67 BBB 8.90% 18.00000% 13.470% 5 0.6 0.4 1.5 BB 11.10% 2.656 24.24800% 14.694% 0.8 0.2 4C 14.30% 43.00000% 17.180% 1.875