Explain why a corporations WACC would likely increase if it

Explain why a corporation\'s WACC would likely increase if it changes the capital structure?(5 points) Lhn a cot ora 1. hange would make he 7 3 2· The risk as measured in standard deviations of a particular security is 10percent and the ewpected return on invested amount is 13 pereent, What is the CV for this security? How would you explain this number? (1o points) ? 101 2 2 (, 00? ) , 010 1 Answer questions 3, 4. 5, and 6 based on the following information from the financial statements of a corporation Total assets $2 billion Total equity $1 billion Total common equity $o.8 billion Cost of preferred stock 1o percent Cost of common stock 13 percent 13 Tax rate 40 percent uo Pretax cost of debt 10 percent o 3. Calculate the WACC for this corporation? (h0 points) 4. What is the capital structure of this corporation in proportions? (5 points) 012 5. How much debt this corporation has? Answer the amount of dollars and as a percentage of assets? (10 points)

Solution

1. Corporation WACC increase if the optimal debt equity structure is not maintained. Some debt is beneficial as cost of debt is tax deductible which reduces the cost of debt. However, excess debt increases the risk of the firm and cost of debt and equity of the firm increases. A all equity firm has higher WACC than a firm with optimal capital; structure because equity is non-tax deductible.

2. CV = (Standard deviation/Return)* 100% = (10/13)* 100% = 76.92%
CV indicates the risk to return ratio of a portfolio. The risk averse investor will try to create a portfolio with low CV.

3. Total Value of firm = DEBT +EQUITY + PREFERRED STOCK =
Debt = Assets - Equity = 2 -1 =1 billion
Preferred stock = Equity - common stock = 1-0.2 = 0.8 billion
Total Value of firm = DEBT +EQUITY + PREFERRED STOCK = 1 + 0.8 + 0.2 = 2 billion

WACC = Weight of equity * cost of equity + Weight of preferred stock * Cost of preferred stock + Weight of debt * cost of debt * ( 1-tax rate)
(0.8/2)* 13% + (0.2/2)* 10% + ( 1/2) * 10% * ( 1-40%) = 9.2%

4)Proportion of equity = (0.8/2) = 40%
Proportion of preferred stock = (0.2/2) = 10%
proportion of debt = (1/2) = 50%

As per chegg policy maxumm one question and 4 subparts can be done at a time
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