Gator Fabrics Inc. currently has zero debt . It is a zero growth company, and additional firm data are shown below. Now the company is considering using some debt, moving to the new capital structure indicated below. The money raised would be used to repurchase stock at the current price. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below. If this plan were carried out, by how much would the WACC change, i.e., what is WACCOld - WACCNew?

Question

Quizplus · Accepted Answer

The correct answer is A.The WACC would change by 2.74%. This is because the cost of debt would increase, while the cost of equity would also increase. The overall effect would be to increase the WACC.