Question 1

A firm shares the following information with you:

EBIT = $25 million; Tax rate = 35%; Debt = $75 million; Cost of debt = 9%; Unlevered cost of capital = 12%The firms creditors indicate that if the firms debt reaches 50% of its total capital value, they would increase interest rate on future financing to 10%. Realizing an increase in the firms borrowing cost; shareholders will also revise their required return to 13%.

a) What is current % of debt used by the firm?

b) Compute the current WACC. How will it change once the percentage debt reaches 50%? Should the firm borrow to increase its debt proportion in its capital structure?