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:
- What is the likely effect on the weighted average cost of capital?
- What might be the impact on firm risk, and the perception of the firm's credit rating? In your response, briefly discuss credit rating agencies and their approach in determining the credit rating itself. What are the key factors of consideration in assignment of the rating?