bld 5932918mbNodeld 2162709478elSBN 9781 305635975 xparentid-216271437 MINDTAP A

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bld 5932918mbNodeld 2162709478elSBN 9781 305635975 xparentid-216271437 MINDTAP Assignment 13-Capital Structure and Leverage ack t0Aig Attempt 7. Capital structure theory Keep the Highest:9 allowed to deduct interest payments as an expense. Corporations allowed to deduct dividend payments to stockholders as an expense. The differential tax treatment of interest payments and dividend payments encourages firms to use capital structure. Debt financing is in their expensive than common or preferred stock financing General Forge and Foundry Corporation currently has no debt in its capital structure, but it is consildering using some debt and reducing its outstanding equity. The firm's unlevered beta is 1.25, and its cost of equity is 12.75% Because the firm has no dett in its capital structure, its weighted average cost of capital (WACC) also equals 12.75%. The risk-free rate of interest (hs) is 4%, and the market nsk premium (RP) 7%. General Forge's marginal tax rate is 35% 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 D/A E/A Bond Cost of Debt Levered Cost of Ratio /E Ratio Rating(ra)Beta (b) Equity (r) WACe 0.0 0.2 0.8 0.25 0A0.6 0.57 B88 7.7% 1.79 16.53% 0.6 0.4 1.50 BB 8.9% 2.47 11.99% 0.8 0.2 1.0 1-25 12.75% 12.75% 72%14.15% 12.26% 4.50 35.50% Type here to search up

Explanation / Answer

Interest Payments are allowed to be deducted as an expense.
Dividend Payments are not allowed to be deducted as an expense.

Differential treatment allows firms to use leverage/debt in their capital structure.
Debt financing is less expensive than equity financing.

D/E Ratio = (D/A)/(E/A)
Cost of Equity = Risk Free Rate + Levered Betax(Market Risk Premium)

BetaLevered = BetaUnlevered x [(1 + (1-t)(D/E)]
WACC = WDx(1-t)xRD + WExRE

Tax Rate 35% Risk Free Rate 4% Risk Premium 7% D/A E/A D/E Bond Rating Rd Levered Beta Rs WACC 0 1 0.00                          -                        -   1.25 12.75% 12.75% 0.2 0.8 0.25 A 7.20% 1.45 14.15% 12.26% 0.4 0.6 0.67 BBB 7.70% 1.79 16.53% 11.92% 0.6 0.4 1.50 BB 8.90% 2.47 21.29% 11.99% 0.8 0.2 4.00 C 11.90% 4.50 35.50% 13.29%

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