Question

1) Blue Ram Brewing Company currently has no debt in its capital structure, but it is considering using some debt and reducing its outstanding equity. The firm’s unlevered beta is 1.15, and its cost of equity is 11.55%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 11.55%. The risk-free rate of interest (rRFrRF) is 3.5%, and the market risk premium (RPMRPM) is 7%. Blue Ram’s marginal tax rate is 25%.

Blue Ram is examining how different levels of debt will affect its costs of debt and equity, as well as its WACC. The firm has collected the financial information that follows to analyze its weighted average cost of capital (WACC). Complete the following table.

D/Cap Ratio	E/Cap Ratio	D/E Ratio	Bond Rating	Before-Tax Cost of Debt (rdrd)	Levered Beta (b)	Cost of Equity (rsrs)	WACC
0.0	1.0	0.00	—	—	1.15	11.55%	11.55%
0.2	0.8	0.25	A	7.2%	?	13.062%	11.530%
0.4	0.6	0.67	BBB	7.7%	1.725	15.575%	?
0.6	0.4	1.50	BB	8.9%	2.444	?	12.248%
0.8	0.2	?	C	11.9%	4.600	35.700%	?

Answer 1

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