Increasing financial leverage increases both the cost of debt (r_debt) and the cost of equity (r_equity). So the overall cost of capital cannot stay constant. This problem is designed to show that the speaker is confused. Buggins Inc. is financed equally by debt and equity, each with a market value of $1 million. The cost of debt is 8%, and the cost of equity is 14%. The company now makes a further issue of debt and uses the proceeds to repurchase equity. This causes the cost of debt to rise to 9% and the cost of equity to rise to 17%. Assume the firm pays no taxes.

a. After the debt issue, what percent of the firm is financed with debt?

b. After the debt issue, what percent of the firm is financed with equity?

c. What is the overall cost of capital?