Items 1 and 2 are based on the following information:
Management of Russell Corporation is considering the following two potential capital structures for a newly acquired business.
|
Alternative 1 |
|
|
Long-term debt, 6% interest |
$3,000,000 |
|
Common equity |
$3,000,000 |
|
Cost of common equity, 10% |
|
|
Marginal tax rate, 15% |
|
|
Alternative 2 |
|
|
Long-term debt, 7% interest |
$5,000,000 |
|
Common equity |
$1,000,000 |
|
Cost of common equity, 12% |
|
|
Marginal tax rate, 15% |
Which of the following statements is not true if management decides to accept Alternative 1?
- Alternative 1 is the more conservative capital structure.
- Alternative 1 provides the greatest amount of financial leverage.
- Net income will be less variable under Alternative 1.
- Total interest expense will be less under Alternative 1.
Which of the alternatives has the lowest weighted-average cost of capital and how much is the differential?
- Alternative 1 by 1.5%
- Alternative 2 by 0.59%
- Alternative 1 by 0.167%
- The alternatives have equal weighted-average cost of capital.