QUESTION 8 0.5 points Save Answer Gator Fabrics Inc. currently has zero debt (i.

Question

QUESTION 8 0.5 points Save Answer Gator Fabrics Inc. currently has zero debt (i.e., Wd old0. 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 calculations WACCnew? Do not round your intermediate d new 40% 60% c new Interest rate new (rd) 6.0% Original cost of equity (rs old) New cost of equity (rs new) Tax rate QA 2.29% 0 B. 1 .96% ° C. 204% OD. 1.65% OE. 2.16% 10.0% 11 .0% 40%

Explanation / Answer

WACC = rD (1- Tc )*( D / V )+ rE *( E / V )

Company currently has zero debt and cost of equity rE =10%

So WACC (old) = rD (1- Tc )*( D / V )+ rE *( E / V)

= rD (1- Tc )*( 0 / V )+ 10% *( E / E)

=0+ 10%

WACC (old) =10%

Proportion of debt = 40% and Proportion of equity = 60%

Interest rate (cost of debt) = 6% and cost of equity (new) = 11%

Tax rate = 40% =0.40

WACC (new) = rD (1- Tc )*( D / V )+ rE *( E / V)

=6% (1- 0.40)* (0.40)+ 11% (0.60)

WACC (new) = 8.04%

WACC (old) - WACC (new) = 10% - 8.04% = 1.96%

Answer: B (1.96%)

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