8. 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 capital than a firm whose earnings are more stable. When bankruptcy costs become more important, they reduce the tax benefits of debt. Blue Ram Brewing Company currently has no debt in its capital structure, but it is considering adding some debt and reducing the percentage of outstanding equity in its capital structure. The firm's current (unlevered) beta is 1.10, and its cost of equity is 11.70. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 11.70. The risk-free rate of interest (IRF) is 4%, and the market risk premium (RPM) is 7%. Blue Ram's marginal tax rate is 30%. 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 WACC. Complete the following table. D/A Ratio E/A Ratio D/E Ratio Bond Rating Before-Tax Cost of Debt Levered Beta (b) 1.10 Cost of Equity (rs) WACC 11.70% 11.70% 1.0 0.8 8.40% 13.03% 11.60% 0.00 0.25 0.67 1. 50 8.90% 1.61 15.27% BBB B B 11.10% 2.26 12.59% ? 14.30% 4.18 33.26% Grade It Now Save & Continue Continue without saving 8. 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 capital than a firm whose earnings are more stable. When bankruptcy costs become more important, they reduce the tax benefits of debt. Blue Ram Brewing Company currently has no debt in its capital structure, but it is considering adding some debt and reducing the percentage of outstanding equity in its capital structure. The firm's current (unlevered) beta is 1.10, and its cost of equity is 11.70. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 11.70. The risk-free rate of interest (IRF) is 4%, and the market risk premium (RPM) is 7%. Blue Ram's marginal tax rate is 30%. 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 WACC. Complete the following table. D/A Ratio E/A Ratio D/E Ratio Bond Rating Before-Tax Cost of Debt Levered Beta (b) 1.10 Cost of Equity (rs) WACC 11.70% 11.70% 1.0 0.8 8.40% 13.03% 11.60% 0.00 0.25 0.67 1. 50 8.90% 1.61 15.27% BBB B B 11.10% 2.26 12.59% ? 14.30% 4.18 33.26% Grade It Now Save & Continue Continue without saving