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 5.8%, and the cost of equity is 11.6%. The company now makes a further $250,000 issue of debt and uses the proceeds to repurchase equity. This causes the cost of debt to rise to 6.0% and the cost of equity to rise to 12.0%. Assume the firm pays no taxes.

a. After the debt issue, what percent of the firm is financed with debt? (Do not round intermediate calculations. Enter your answer as a whole percent.)

b. After the debt issue, what percent of the firm is financed with equity? (Do not round intermediate calculations. Enter your answer as a whole percent.)

c. What is the overall cost of capital? (Enter your answer as a percent rounded to 1 decimal place.)

Question

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 5.8%, and the cost of equity is 11.6%. The company now makes a further $250,000 issue of debt and uses the proceeds to repurchase equity. This causes the cost of debt to rise to 6.0% and the cost of equity to rise to 12.0%. Assume the firm pays no taxes.

a. After the debt issue, what percent of the firm is financed with debt? (Do not round intermediate calculations. Enter your answer as a whole percent.)

b. After the debt issue, what percent of the firm is financed with equity? (Do not round intermediate calculations. Enter your answer as a whole percent.)

c. What is the overall cost of capital? (Enter your answer as a percent rounded to 1 decimal place.)

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Increasing financial leverage increases both the cost of debt ( r debt ) and the cost of equity ( r equity ). So the overall

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