B & C Corp. is panning to spend large amounts of money on R&D over the next few years and feels that it may not be able to use all the tax shields generated by a 42.75% debt ratio. The company considers lowering the debt ratio to 20%. HOW will this change its WACC and cost of equity? Assume that the lower debt ratio will reduce the before-tax cost of debt to 8%.
【Hint: The change in debt ratio will lower the cost of equity. The problem can be solved by using the “three step” process of unlevering and relevering the WACC.)
Ref. Step 1: Unlever the WACC to calculate the opportunity cost of capital r.
Step 2: Calculate the cost of equity at 20% debt ratio.
Step 3: Calculate the new WACC.
[Remember: r = rD D/V + rEE/V, rE = r + ( rA ーrD )D/E ]
2007-06-04 23:00:59 · 2 answers · asked by Anonymous in Business & Finance ➔ Investing