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9 January, 09:43

Company XYZ has a target capital structure of 50% equity and 50% debt. Its cost of equity is 6%, and cost of debt is 8% What would happen to XYZ's WACC if its capital structure were to shift to 75% equity and 25% debt? Assume a tax rate is40%.

A. WACC decrease

B. WACC increases

C. WACC remains constant

+2
Answers (1)
  1. 9 January, 12:29
    0
    Option (B) is correct.

    Explanation:

    WACC = (We * ke) + [Wd * kd * (1 - t) ]

    where,

    We = Equity

    Wd = Debt

    ke = cost of equity

    kd = cost of debt

    t = tax rate

    At 50% equity and 50% debt,

    WACC = (50% * 6%) + [50% * 8% * (1 - 0.4) ]

    = 5.40%

    At 75% equity and 25% debt,

    WACC = (75% * 6%) + [25% * 8% * (1 - 0.4) ]

    = 5.70%

    Therefore, there is an increase in the XYZ's WACC if its capital structure were to shift to 75% equity and 25% debt.
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Home » Business » Company XYZ has a target capital structure of 50% equity and 50% debt. Its cost of equity is 6%, and cost of debt is 8% What would happen to XYZ's WACC if its capital structure were to shift to 75% equity and 25% debt? Assume a tax rate is40%. A.
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