Relationships between capital costs and leverage as measured

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Reference no: EM131536966

David Lyons, CEO of lyons Solar Technologies, is concerned about his firm's level of debt financing. The company uses short term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies average about 30% debt, and Mr, Lyons wonders why they use so much more debt and how it affects stock prices. To gain some insights into matter, he poses the following question to you his recently hired assistant. Please answer the following question in your own words. Assume that firms U and L are in the same risk class and that both have EBIT=$500,000. FIrms U uses no debt financing and its cost of equity is rsu=14%. Firm L has $1 million of debt outstanding at a cost of Rd=8% There are no taxes Assume that the MM assumptions hold. Please answer the following questions

1. Find V, S, rs, and WACC for firms U and L.

2. Graph(a) the relationships between capital costs and leverage as measured by D/V and (b) the relationship between V and D.

Reference no: EM131536966

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