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Capital Structure, Equity Financing and Financial Leverage

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The financial manager of a firm determines the following schedules of cost of debt and cost of equity for various combinations of financing:

Debt/Assets After-Tax Cost of Debt Cost of Equity
0% 4% 8%
10 4 8
20 4 8
30 5 8
40 6 10
50 8 12
60 10 14
70 12 16

A. Find the optimal capital structure (that is, optimal combination of debt and equity financing).
B. Why does the cost of capital initially decline as the firm substitutes debt for equity financing?
C. Why will the cost of funds eventually rise as the firm becomes more financially leveraged?

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The financial manager of a firm determines the following schedules of cost of debt and cost of equity for various combinations of financing:
Debt/Assets After-Tax Cost of Debt Cost of Equity
0% 4% 8%
10 4 8
20 4 8
30 5 8
40 6 10
50 8 12
60 10 14
70 12 16

A. Find the optimal capital structure (that is, optimal combination of debt and equity ...

Solution Summary

The following posting helps with questions regarding optimal capital structure, equity financing and financial leverage.

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