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41 8 5. The relationship between a firm's capital structure and othercompany attributes As a firm takes on more debt, its probability of bankruptcy A-Z faces a Other factors held constant, a firm whose earnings are relatively volatile chance of bankruptcy. Therefore, when other factors are held constant, a firm whose earnings are relatively volatile should use debt than a more stable firm. When bankruptcy costs become more important, they the tax benefits of debt. General Forge and Foundry Corporation 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 1.25, and its cost of equity is 13.00%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 13.00 %. The risk-free rate of interest (r) is 3%, and the market risk premium (RPM) is 8%. General Forge's marginal tax rate is 25%. General Forge 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. E/Cap Bond Before-Tax Cost of Debt ( Levered Beta Cost of Equity ( D/Cap Ratio Ratio D/E Ratio Rating Ta) (b) F.) WACC 0,0 1.0 0.00 1.25 13.00% 13.00% 0.2 0.8 0.25 8.4% 14.872% 13.156% 0.4 0.6 0.67 888 8.9% 1.875 18.000% 0.6 0.4 1.50 BB 11.1% 2.656 14.694% 0.8 0.2 14.3% 5.000 43.000% Save & Continue Continue without saving Grade It Now