A firms current balance sheet is as follows:

Assets $110 Debt $ 22 Equity $ 88

a. What is the firms weighted-average cost of capital at various combinations of debt and equity, given the following information? Round your answers to one decimal place.

Debt/Assets After-Tax Cost of Debt Cost of Equity Cost of Capital

0% 8% 15% ____%

10 8 15 _____

20 9 15 ____

30 9 15 ______

40 11 16 ______

50 13 16 _______

60 15 16 _______

b. Construct a pro forma balance sheet that indicates the firms optimal capital structure. Choose the best structure from the options analyzed in part a. Compare this balance sheet with the firms current balance sheet. Round your answers to the nearest dollar.

Assets $ 110 Debt $ _____ Equity $____

What course of action should the firm take? Round your answer to the nearest whole number.

Since the firm is currently using ____% debt financing, it -Select- at its optimal capital structure and -Select-

c. As a firm initially substitutes debt for equity financing, what happens to the cost of capital? The cost of capital initially -Select-

d. If a firm uses too much debt financing, why does the cost of capital rise? If a firm uses too much debt financing, the firm becomes -Select- financially leveraged and riskier. This causes the interest rate to -Select- and the cost of equity to -Select- . These changes in the cost of debt and equity