1)The firm is curently financed with 10% debt and 90% equity. However the CFO pr

Question

1)The firm is curently financed with 10% debt and 90% equity. However the CFO proposed that the firm issues new long term debt and repurchase some of the firm's common stock. Firm's advisors believe the long term debt would require a before tax yield of 10$ while the firm's basic earning power (BEP) is 14%. The firm's operating income and total assets will not be affected. The CFO has told the rest of th management team that he believes this move will increase the firm's stock price. If the firm proceeds with th erecapitalization, which of the followints items is also likely to increse (it can be more than one):

Net Incom

ROA

Cost of Equity

Cost of Debt

Basic earning power

2) The CFO's proposal has opened up a dialogue among the company's management team about the effects of debt financing. In paritcular, one manager notes that debt financing is cheaper than equity financing. He suggest that using more debt always will decrease the firm's WACC. Is this true? Why or why not?

Explanation / Answer

Cost of Equity

true

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