Assume that you have just been hired as business manager of Campus Deli$($CD$),$ which is located adjacent to the campus. Its Free Cash Flow$($FCF$)$ is $$30,000.$ Because the university's enrollment is capped, FCF is expected to be constant over time. Because no expansion capital is required, $CD$ pays out all earnings as dividends. CD currently has no debt $-$ it is an all$-$equity firm $-$ and its $100,000$ shares outstanding. The firm's federal$-$plus$-$state tax rate is $40\%.$

On the basis of statements made in your finance text, you believe that CD$\text{'}$s shareholders would be better off if some debt financing was used. When you suggested this to your new boss, she encouraged you to pursue the idea but to provide support for the suggestion.

In today's market, the risk$-$free rate is $6\%$ and the market risk premium is $6\%.CD\text{'}$s unlevered beta is $1\mathrm{.}0.CD$ currently has no debt, so its cost of equity $($and WACC$)$ is $12\%.$ If the firm was recapitalized, debt would be issued and the borrowed funds would be used to repurchase stock. After speaking with a local investment banker, you obtain the following estimates of the cost of debt at different debt levels $($in thousands of dollars$)$:

$\backslash$table$[[$Debt$/$Asset Ratio,Bond Rating,Yield$],[0,---,---],[0,2,$AA$,8,0\%$