UInc. currently has zero debt (i.e., Wd=0). It is a zero growth company, and add

Question

UInc. currently has zero debt (i.e., Wd=0). 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 mmuch would the WACC change, i.e., what is WACCold - WACCnew?

Wd= 35%                                          Orig. Cost of equity, rs = 9.5%

We= 65%                                          New Cost of Equity= rs = 10.5%

Interest rate new= rd = 6.0%               Tax Rate = 35%

Explanation / Answer

WACC New= Wd * New Interest Rate * (1-Tax rate) + Wc*rs

WACC New = (0.35) * (0.06) * (1-0.35) + (0.65)(0.105)

WACC New = 0.0819 = 8.19%

WACC Change = WACC Old - WACC New

WACC Change = 9.5 % - 8.19%

WACC Change = 1.31%

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