18. Assume that your company currently has the following characteristics:

D/V = .75 Rf = 4%

E/V = .25 Market Risk Premium = 5.5%

Beta = 2.0 tax rate = 40%

Current EBIT = 1,000,000 Interest = 630,000

In addition, you obtain the following data from a rating agency, with interest coverage:

greater than	to	Rating is	Spread is
1.25	1.499	CCC	8.75%
1.50	1.999	B-	6.75%
2.00	2.499	B	6.00%
2.50	2.999	B+	5.50%
3.00	3.499	BB	4.75%
3.50	3.999	BB+	3.75%
4.00	4.499	BBB	2.50%
4.50	5.999	A-	1.65%
6.00	7.499	A	1.40%

1. Estimate the current cost of capital for your company.
2. Prior management highly leveraged the firm to capture the tax advantages associated with debt. Current management is concerned that the firm may have gone too far and is considering changing the capital structure to 25% debt and 75% equity. The reduction in debt is not expected to change operating income but is expected to reduce interest expense to 1/3 of its current amount. Do you agree or disagree with the decision, and why? (Your answer should include the pros and cons of leverage and include numerical support for your conclusion.)