. The relationship between a firm's capital structure and other company attributes As a firm takes on more debt, its probability of bankruptcy . Other factors held constant, a firm whose earnings are relatively volatile faces a chance of bankruptcy. Therefore, when other factors are held constant, a firm whose earnings are relatively volatile should use debt than a more stable firm. When bankruptcy costs become more important, they the tax benefits of debt. Blue Ram Brewing Company 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 1.15, and its cost of equity is 11.55%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 11.55%. The risk-free rate of interest (rRFrRF) is 3.5%, and the market risk premium (RPMRPM) is 7%. Blue Ram’s marginal tax rate is 25%. Blue Ram 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. D/Cap Ratio E/Cap Ratio D/E Ratio Bond Rating Before-Tax Cost of Debt (rdrd) Levered Beta (b) Cost of Equity (rsrs) WACC 0.0 1.0 0.00 — — 1.15 11.55% 11.55% 0.2 0.8 0.25 A 7.2% 13.062% 11.530% 0.4 0.6 0.67 BBB 7.7% 1.725 15.575% 0.6 0.4 1.50 BB 8.9% 2.444 12.248% 0.8 0.2 C 11.9% 4.600 35.700%

Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter21: Dynamic Capital Structures And Corporate Valuation

Section: Chapter Questions

Problem 3MC: David Lyons, CEO of Lyons Solar Technologies, is concerned about his firms level of debt financing....

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. The relationship between a firm's capital structure and other company attributes

As a firm takes on more debt, its probability of bankruptcy . Other factors held constant, a firm whose earnings are relatively volatile faces a chance of bankruptcy. Therefore, when other factors are held constant, a firm whose earnings are relatively volatile should use debt than a more stable firm. When bankruptcy costs become more important, they the tax benefits of debt.

Blue Ram Brewing Company 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 1.15, and its cost of equity is 11.55%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 11.55%. The risk-free rate of interest (rRFrRF) is 3.5%, and the market risk premium (RPMRPM) is 7%. Blue Ram’s marginal tax rate is 25%.

Blue Ram 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.

D/Cap Ratio	E/Cap Ratio	D/E Ratio	Bond Rating	Before-Tax Cost of Debt (rdrd)	Levered Beta (b)	Cost of Equity (rsrs)	WACC
0.0	1.0	0.00	—	—	1.15	11.55%	11.55%
0.2	0.8	0.25	A	7.2%		13.062%	11.530%
0.4	0.6	0.67	BBB	7.7%	1.725	15.575%
0.6	0.4	1.50	BB	8.9%	2.444		12.248%
0.8	0.2		C	11.9%	4.600	35.700%

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