Assume that with a capital structure of 20% debt and 80% equity the cost of debt is 10% and cost of equity is 14%. The tax rate is 40%. The current value of the business is $ 500,000. The finance manager of the company is recommending a change of capital structure to 80% debt and 20% equity. He states that at effective cost of debt of 10% the increase of debt in capital structure would always increase the value of the firm.

He further adds that the cost of equity will remain the same at any level of debt as it should not only increase the earnings but also decrease the beta of the companys stock.

1. Do you agree with the recommendation and reasoning of the finance manager? Give three reasons as to why you agree with the reasoning?

In case you dont agree give three reasons in support of your response