Question

Green Goose Automation 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 12.70%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 12.70%. The risk-free rate of interest (rRFrRF) is 3.5%, and the market risk premium (RP) is 8%. Green Goose’s marginal tax rate is 30%.

Green Goose 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/A Ratio	E/A Ratio	D/E Ratio		Before-Tax	Levered	Cost of	WACC
			Bond	Cost of Debt	Beta	Equity
			Rating	(rdrd)	(b)	(rsrs)
0.0	1.0	0.00	—	—	1.15	12.70%	12.70%
0.2	0.8	0.25	A	8.4%	?	14.30%	12.62%
0.4	0.6	0.67	BBB	8.9%	1.69	17.02%	?
0.6	0.4	1.50	BB	11.1%	2.36	?	13.61%
0.8	0.2	?	C	14.3%	4.37	38.46%	?

Answer 1