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# Calculate WACC; Construct a Pro Forma Balance Sheet

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A firm's current balance sheet is as follows:

Assets \$100 Debt \$10 Equity \$90

a. What is the firm's weighted-average cost of capital at various combinations of
debt and equity, given the following information?

Debt/Assets After-Tax Cost of Debt Cost of Equity Cost of Capital
0% 8% 12%
10 8 12
20 8 12
30 8 13
40 9 14
50 10 15
60 12 16

b. Construct a pro forma balance sheet that indicates the firm's optimal capital structure. Compare this balance sheet with the firm's current balance sheet. What course of action should the firm take?

Assets \$100 Debt \$ Equity \$
c. As a firm initially substitutes debt for equity financing, what happens to the cost of capital, and why?

d. If a firm uses too much debt financing, why does the cost of capital rise?

#### Solution Preview

A firm's current balance sheet is as follows:

Assets \$100 Debt \$10 Equity \$90

a. What is the firm's weighted-average cost of capital at various combinations of
debt and equity, given the following information?

Debt/Assets After-Tax Cost of Debt Cost of Equity Cost of Capital
0% 8% 12% ?
10 8 12 ?
20 8 12 ?
30 8 13 ?
40 9 14 ?
50 10 15 ?
60 12 16 ?

After Tax
cost of Cost of Cost of
Debt/Assets debt Equity Capital
0% 8% 12% 12.00%
10% 8% 12% 11.60%
20% 8% 12% 11.20%
30% 8% 13% 11.50%
40% 9% 14% 12.00%
50% 10% 15% 12.50%
60% 12% 16% 13.60%

WACC = Proportion of debt X ...

#### Solution Summary

The solution explains how to calculate the WACC and use the WACC for constructing a pro-forma balance sheet in 423 words.

\$2.19