You are in a board room meeting for the tech company Cloud Co. that specializes in cloud storage and the discussion entails the amount of debt the firm should have in its capital structure. You hear some of the board members, some of who do not have a lot of direct financial experience talking to one another. The CFO and controller are there do given input and you are tasked with summing up the meeting notes and having a follow up discussion with the CFO. Here is what you hear and how you think the response should be:

1. Ben Rhodes, a board member who is a former state congressman says that Cloud Co. should increase its debt level above its current 40% level to upwards of 60% as interest rates are really low and interest can be written off. Which is most correct?

1. Higher debt levels will increase operating leverage, which will lower the DTL
2. Increasing debt should cause financial risk to rise and raise the cost of debt
3. Increasing debt should increase the DFL which will raise the DTL all else equal
4. Interest is not tax deductible so his statement is incorrect to begin with
5. Both b & c

2. Another board member states that the cost of equity is the most expensive part of the capital structure of Cloud Co. The rest of the board agrees and you hear some other talk, some of which you try to decipher. Which answer do you think is most accurate.

1. Common equity is most expensive because it gets paid off after bonds and hence riskier.
2. Common equity holders own the firm which entitles them to distributions of profits, so other providers of capital are giving up this advantage.
3. Common equity holders have unlimited upside in return potential whereas bonds do not.
4. The cost of equity to the firm is the required return to the equity investor. As such, all of the above are essentially true.
5. All of the above

3. T/F The goal of the board is to find the % mix of debt and equity that will maximize the WACC as this will maximize share price.

Several board members discuss using stock to raise capital as they do not want to hurt Cloud Co. credit rating. What makes the most sense:

4. a. Issuing stock will decrease the debt to ebitda ratio

b. Issuing stock will increase ROE

c. Issuing stock will decrease NI

d. Issuing stock will increase EPS