Using the information is the previous problem, the president suggest that Madiso

Question

Using the information is the previous problem, the president suggest that Madison take on more debt in the future to finance additional positive net present value projects. She estimates that a 60% debt and 40% equity mixture for the entire corporation is better. If Madison adopts this new debt oriented structure the cost of equity will increase to 14% and the cost of debt will increase to 7.0%. Please recalculate and report the new weighted average cost of capital and determine if Madison should stay where it is or adopt the higher debt oriented capital structure? (round at 2 decimal places)

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Revised WACC = Revised Weight of Debt*Revised Cost of Debt + Revised Weight of Equity*Revised Cost of Equity = .60*7 + .40*14 = 9.80%

Conclusion:

In the previous problem, the company's WACC was 9.20%. After considering the revision, the company's WACC increase to 9.80%. Therefore, it is not advisable to adopt the higher debt oriented capital structure.

Thanks.

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