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?
Wd 55% Orig. cost of equity, rs 10.0%
Wc 45% New cost of equity = rs 11.0%
Interest rate new = rd 7.0% Tax rate 40%
A) 2.74%
B) 3.01%
C) 3.32%
D) 3.65%
E) 4.01%

Question

Quizplus · Accepted Answer

WACCOld = 10.0%WACCNew = 0.55 * 10.0% + 0.45 * 11.0% * (1 - 0.4) + 0.45 * 7.0% * (1 - 0.4) = 10.27%WACCOld - WACCNew = 10.0% - 10.27% = -0.27% = -2.74%