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Girard Manufacturing Ltd. (GML) has historically operated with NO long-term debt in its capital structure. The cost of GML's equity is currently 10%. GML's financial advisor has suggested raising debt in order to change its capital structure to 70% equity and 30% debt, and use the funds to buy back a portion of its equity. The financial advisor has estimated that a debt issue would require an annual yield of 5.5%. The after-tax flotation cost of issuing new debt is 3%. The financial advisor also expects that the cost of GML's equity with the new capital structure will increase to 11%. GML is subject to tax at a rate of 40%.
Question 1: Calculate GML's new weighted average cost of capital if it changes its capital structure to that suggested by the financial advisor
Question 2: Explain whether GML should change its structure
Question 3: Explain why firms generally desire a lower weighted average cost of capital.
Question 4: Describe two disadvantages of adding debt to a firm's capital structure
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