James Bay Water Park Company and Lanudiere Resort Company operate in a world with taxes and no financial distress.James Bay Water Park has a debt/equity ratio of 1.The cost of equity to James Bay Water Park is 15 percent and the cost of debt is 8 percent.The only difference between Lanudiere Resort Company and James Bay Water Park is that Lanudiere Resort has a debt/equity ratio of 2.According to M&M,the weighted average cost of capital for Lanudiere Resort should be:

Question

Quizplus · Accepted Answer

According to Modigliani and Miller (M&M) Proposition II with taxes, the weighted average cost of capital (WACC) decreases as the debt/equity ratio increases due to the tax shield on debt. Since Lanudiere Resort has a higher debt/equity ratio than James Bay Water Park, its WACC should be lower.

James Bay Water Park Company and Lanudiere Resort Company Operate