| Course | IBF-5040 Corporate and Managerial Finance |
|---|---|
| Module | Module 6 |
| Paper type | Module 6 written assignment: the cost of capital and optimal capital structure |
| Length | About 590 words, 5 pages |
| Format | APA 7 student paper |
| School | Thomas Edison State University |
| Program | MBA in Finance |
| Updated | October 2026 |
Free sample paper for IBF 5040 Module 6
Less Debt, Lower Cost: The Cost of Capital and Capital Structure at Passaic Precision
Student Name
MBA in Finance, Thomas Edison State University
IBF-5040: Corporate and Managerial Finance
Mentor Name
Month Day, Year
Less Debt, Lower Cost: The Cost of Capital and Capital Structure at Passaic Precision
Introduction
Earlier modules found that Passaic's notes yield 7.2 percent and its shares require about 11.2 percent. Here they are blended into one WACC, and the question becomes whether Passaic carries the right amount of debt. The answer matters for the board's decision, because a debt-financed buyback would push the company's debt share higher at the moment its lenders are watching coverage most closely. The calculations below use market prices from the end of 2024. Moyer et al. (2018) define the weighted average cost of capital as the minimum return a firm must earn on new investments of average risk.
Market-Value Weights
The cost of capital should use market values, because investors require returns on what their claims are worth today. Passaic's 20 million shares at about $14 give equity of $280 million. Its notes, priced at about 95 percent of face, and other debt give total debt of about $255 million. Equity is therefore about 52 percent of capital and debt 48 percent.
The Weighted Average Cost of Capital
The WACC of about 8.5 percent is the return the company's existing assets must earn to satisfy all investors. The machining cell from Module 5, with an IRR near 12 percent, clears it comfortably, and its NPV at 8.5 percent would exceed the $4.8 million found at the 9 percent hurdle.
| Component | Weight | Cost | Weighted cost |
|---|---|---|---|
| Debt, after tax: 7.2% x 0.79 | 48% | 5.69% | 2.73% |
| Equity, from the CAPM | 52% | 11.18% | 5.81% |
| WACC | | | 8.54% |
Testing a Different Capital Structure
To see whether less debt would lower the cost of capital, the company's beta can be unlevered and relevered using the Hamada relationship. Removing the effect of current debt gives an unlevered beta of about 0.73. At a target of 30 percent debt, the relevered beta is about 0.97, lowering the cost of equity to about 9.7 percent, and the lower debt load would likely restore an investment-grade rating, cutting the pretax cost of debt to about 6.6 percent.
| Target debt share | Cost of equity | After-tax cost of debt | WACC |
|---|---|---|---|
| 48% (current) | 11.2% | 5.7% | 8.5% |
| 30% | 9.7% | 5.2% | 8.3% |
Trade-Off Theory
Modigliani and Miller (1958) showed that in a world without taxes or distress costs, capital structure would not affect value. Taxes make debt valuable through the interest deduction, while distress costs make too much of it harmful. The optimal structure balances the two. Passaic's interest coverage of 3.6 times, a rating just below investment grade and covenants near their limits suggest it is on the costly side of that balance: reducing debt would lower expected distress costs, protect access to credit in a downturn and lower the WACC slightly.
Implications for the Buyback
A debt-financed buyback would move the company further toward the high-debt end, raising both component costs and the risk of a downgrade. The analysis points the other way: Passaic should finance growth, such as the machining cell, with retained earnings and inventory reductions, and gradually reduce debt toward about 30 percent of capital. Shleifer and Vishny (1997) observe that debt can discipline managers by committing cash to interest, but Passaic's existing obligations already provide that discipline, and adding more would mostly add risk.
Conclusion
Passaic's WACC is about 8.5 percent with debt near half of capital. Relevering beta and repricing debt suggest that a structure with about 30 percent debt would lower the WACC to about 8.3 percent and reduce distress risk. The capital structure analysis therefore weighs against the activist's proposal.
References
Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. The American Economic Review, 48(3), 261-297.
Moyer, R. C., McGuigan, J. R., & Rao, R. P. (2018). Contemporary financial management (14th ed.). Cengage.
Shleifer, A., & Vishny, R. W. (1997). A survey of corporate governance. Journal of Finance, 52(2), 737-783. https://doi.org/10.1111/j.1540-6261.1997.tb04820.x
IBF 5040 Module 6 instructions, in plain terms
Assignment six of IBF-5040 asks what Passaic's capital costs and how much debt suits it. Prompts ask for each source's cost, market weights, the WACC and the effect of a different debt mix, often with Hamada used to relever beta. Questions also ask about capital structure theories, Modigliani and Miller, trade-off and pecking order. Show weights and component costs in a table and explain each assumption, especially the cost of debt at a new rating. State the date and source of the share price, the debt's market value and any rating you assume. When testing a new capital structure, show the unlevered beta and the relevered beta at each debt level. Explain how the result connects to the company's coverage, covenants and rating, since those determine whether a different structure is realistic.
How the IBF 5040 Module 6 example is put together
The paper connects the component costs from earlier modules to this one. A section explains market-value weights and computes them. A table builds the WACC. A section relevers beta to test a 30 percent debt structure and reprices debt at a better rating, summarized in a comparison table. A theory section applies Modigliani and Miller and trade-off reasoning to the company's coverage and covenants. The final sections connect the results to the buyback debate that has run since Module 1. Every figure in the tables comes from an earlier module or from a calculation shown in the text, which keeps the analysis consistent across the course. The paper treats capital structure as a judgment informed by theory and by the company's situation rather than as a formula. Its recommendation is specific, a target debt share, and explains how the company could reach it without disrupting its investment plans.
Where the marks sit in the IBF 5040 Module 6 rubric
Mentors grade this assignment on correct component costs, market-value weights and WACC, sound use of the Hamada relationship and clear application of capital structure theory. Answers that recompute both the cost of equity and the cost of debt at a new structure show the understanding mentors look for. Linking the WACC to project evaluation and to financing decisions demonstrates integration. Clear tables and stated assumptions support the grade. Mentors also check that the cost of equity comes from a method the student explains, such as the CAPM, and that the tax rate matches the one used elsewhere. Papers that explain why the WACC changes only slightly across a range of debt levels, and why distress costs matter more than the small WACC change suggests, show depth beyond the calculation.
Common IBF 5040 Module 6 mistakes, and how to avoid them
Marks fall for book weights, a pretax cost of debt or a new debt ratio tested with the old component costs. Use market values. Apply the tax rate to interest. Relever beta and reprice debt at each structure you test. Explain why the result fits the company's coverage and rating. Some students also assume the cost of debt stays fixed at every debt level, which makes more debt always look cheaper. Price debt at the rating each structure would likely earn. Explain how distress costs, such as lost customers or restrictive covenants, affect a company like yours, and keep the recommendation consistent with the cash flow needs identified in earlier modules. A free first sample on your own IBF-5040 Module 6 problems is available on request.
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IBF 5040 Module 6 questions, answered
Where can I find a free IBF 5040 Module 6 sample paper?
WACC at market weights and a relevered beta at 30 percent debt are calculated above.
Why use market-value weights in the WACC?
Because investors require returns on the current value of their claims, not on historical book amounts.
What is the Hamada relationship?
A formula that unlevers a beta to remove the effect of debt and relevers it at a different debt-to-equity ratio.
What does trade-off theory say?
Debt adds value through tax savings until expected financial distress costs outweigh them, so an optimal debt level exists.
Does more debt always lower the WACC?
No. Beyond a point, higher costs of equity and debt from financial risk raise the WACC.