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A firm shares the following information with you:
EBIT = $45 million; Tax rate = 35%; Debt = $ 100 million; Cost of debt = 7 %; Unlevered cost of capital = 14%
The firm's creditors indicate that if the firm's debt reaches 50% of its total capital value, they would increase the interest rate on future financing to 9 %. Realizing an increase in the firm's borrowing cost; shareholders will also revise their required return to 15%.
i) What is the current % of debt used by the firm?
ii) Compute the current WACC. How will it change, once the percentage of debt reaches 50%? Should the firm borrow to increase its debt proportion in its capital structure?
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