5. The relationship between a firm's capital structure and other company attributes As a firm takes on more debt, its probability of bankruptcy increases . Other factors held constant, a firm whose earnings are relatively volatile faces a greater chance of bankruptcy. Therefore, when other factors are held constant, a firm whose earnings are relatively volatile should use less debt than a more stable firm. When bankruptcy costs become more important, they reduce the tax benefits of debt. 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 1.2, and its cost of equity is 12.40%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 12.40%. The risk-free rate of interest (IRP) is 4%, and the market risk premium (RPM) is 7%. 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 D/Cap Ratio E/Cap Ratio Before-Tax Cost of Debt Levered Beta (4) (b) WACC 0.0 1.0 D/E Ratio 0.00 0.25 1.2 12.40% 0.8 Bond Rating - BBB BB C 7.2% 1.425 12.40% 13.975% 16.600% 12.260% 0.67 7.7% 1.800 12.270% 0.6 0.4 1.50 8.9% 2.550 12.745% 0.2 4.00 11.9% 4.800 37.600% 5. The relationship between a firm's capital structure and other company attributes As a firm takes on more debt, its probability of bankruptcy increases . Other factors held constant, a firm whose earnings are relatively volatile faces a greater chance of bankruptcy. Therefore, when other factors are held constant, a firm whose earnings are relatively volatile should use less debt than a more stable firm. When bankruptcy costs become more important, they reduce the tax benefits of debt. 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 1.2, and its cost of equity is 12.40%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 12.40%. The risk-free rate of interest (IRP) is 4%, and the market risk premium (RPM) is 7%. 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 D/Cap Ratio E/Cap Ratio Before-Tax Cost of Debt Levered Beta (4) (b) WACC 0.0 1.0 D/E Ratio 0.00 0.25 1.2 12.40% 0.8 Bond Rating - BBB BB C 7.2% 1.425 12.40% 13.975% 16.600% 12.260% 0.67 7.7% 1.800 12.270% 0.6 0.4 1.50 8.9% 2.550 12.745% 0.2 4.00 11.9% 4.800 37.600%