Suppose Jack, president of Heart Limited has hired you to advise on the firms cost of capital. (a) Based on the most recent financial statements, Hearts total liabilities are $8 million. Total interest expense for the coming year will be about $1 million. Jack therefore reasons, We owe $8 million, and we will pay $1 million interest. Therefore, our cost of debt is obviously $1 million/8 million = 12.5%. Appraise Jacks statement.

(b) The company paid $1 million of dividends in the past year. Its market capitalization was $10 million. Based on his own analysis, Jack suggests that the company increases its use of equity financing, because debt costs 12.5 percent, but equity only costs 10 percent; thus, equity is cheaper. Appraise Jacks statement.

"Heart Limited has one bond in issue expiring in eight years, paying 0 coupon and has a face value of $1000. It is currently traded at $720, Beta =1.2, risk free rate is 2%, historic market risk premium is 5.5%. Assume the ratio of debt to equity is 2:1, and corporate tax rate is 20%." (c) Determine the WACC for Heart Limited.