Suppose the debt ratio (D/TA) is 50%, the interest rate on new debt is 8%, the current cost of equity is 16%, and the tax rate is 40%. An increase in the debt ratio to 60% would have to decrease the weighted average cost of capital (WACC).

Question

Quizplus · Accepted Answer

An increase in the debt ratio increases financial risk, which can increase the cost of equity. The WACC may not decrease if the increase in the cost of equity outweighs the tax shield benefit from the increased debt.

Suppose the Debt Ratio (D/TA) Is 50%, the Interest Rate