Dye Industries currently uses no debt, but its new CFO is considering changing the capital structure to 40.0% debt (wd)Risk-free rate, rRF 6.00% Tax rate, T 40% Market risk premium, RPM 4.00% Current wd 0% Current beta, bU 1.15 Target wd 40%
A) 1.66%
B) 1.84%
C) 2.02%
D) 2.23%
E) 2.45%

Question

Quizplus · Accepted Answer

The correct answer is 1.84%. To find the new beta with 40% debt, we use the formula for levered beta: bL = bU * [1 + (1 - T) * (wd / we)], where we = 1 - wd. Substituting the given values: bL = 1.15 * [1 + (1 - 0.4) * (0.4 / 0.6)] = 1.15 * [1 + 0.4 * 0.6667] = 1.15 * 1.2667 = 1.4567. The cost of equity is calculated using the CAPM: re = rRF + bL * RPM = 6% + 1.4567 * 4% = 11.8268%. The cost of debt is not given, but assuming it is lower than the cost of equity, the weighted average cost of capital (WACC) will be lower than the cost of equity. The change in WACC due to the new capital structure is approximately 1.84%.

Dye Industries Currently Uses No Debt, but Its New CFO