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Felicia & Fred

Now that the board members of Felicia & Fred are planning to implement a new crystal jewelry product line, they are concerned about potential shareholder sentiment regarding the dilution of ownership interest. As a result of this, the board is giving consideration to a significant change in capital structure in order to raise the cash required to fund the project. This would change the current capital structure from 30% debt and 70% equity to 70% debt and 30% equity.

Although shareholder sentiment may be appeased by this approach, discuss the following considerations that may emerge as a result of this drastic change in capital structure from a qualitative perspective:

Question 1

What is the likely effect on the weighted average cost of capital?  Explain by example.

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