Company xyz has a target capital structure of 50% equity and 50% debt. its cost of equity is 6%, and cost of debt is 8% what would happen to xyz's wacc if its capital structure were to shift to 75% equity and 25% debt? assume a tax rate is40%.

a. wacc decrease
b. wacc increases
c. wacc remains constant

Option (B) is correct.

Explanation:

WACC = (We × ke) + [Wd × kd × (1 - t)]

where,

We = Equity

Wd = Debt

ke = cost of equity

kd = cost of debt

t = tax rate

At 50% equity and 50% debt,

WACC = (50% × 6%) + [50% × 8% × (1 - 0.4)]

           = 5.40%

At 75% equity and 25% debt,

WACC = (75% × 6%) + [25% × 8% × (1 - 0.4)]

           = 5.70%

Therefore, there is an increase in the XYZ's WACC if its capital structure were to shift to 75% equity and 25% debt.

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