WIZE Corp operates in a country with no taxes and no risk of financial distress…

Weighted-Average Cost of Capital

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WIZE Corp operates in a country with no taxes and no risk of financial distress. Currently the firm has a D/E ratio of 3.5, a cost of debt of 8% and a cost of equity of 15%. Cyrus, a senior analyst, states that if the firm increases their use of debt their WACC should decrease. Cyrus is:

A) Correct because as we increase the use of debt the WACC should decrease as we are
increasing our use of a cheaper source of capital (cost of debt < cost of equity).

B) Correct because according to M&M the value of the firm is unchanged as we increase
the level of debt but the net income of the firm will decline (due to increased interest
payments). The only way the value of the firm can remain the same is if the WACC
decreases.

C) Incorrect because as we increase the use of debt we increase the riskiness of the
equity and therefore the cost of equity will increase. The net effect is that the WACC
remains constant.

D) Incorrect because the firm’s D/E ratio is already above the firm’s optimal level and
any further increase in debt will result in an increase in WACC and a decrease in firm
value.

I don't know

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Question 2
A firm has a weighted average cost of capital of 15.6%. The company's cost of debt is 10% before tax and has a debt to equity ratio of 120%. The company's tax rate is 40%. What is the cost of equity?

Question 1
What is the average cost of capital for a firm with a debt-to-equity ratio of 80%. The before-tax cost of debt is 6%, the beta of its common shares is 1.5, the market risk premium is 8% and t-bills are yielding 4%. The company's tax rate is 30%.

WIZE Corp operates in a country with no taxes and no risk of financial distress…

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Weighted-Average Cost of Capital

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