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Company XYZ has a target capital structure of 30% equity and 70% debt. Its cost of...

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Finance

Company XYZ has a target capital structure of 30% equity and 70%debt. Its cost of equity is 10%, and cost of debt is 5%. What wouldhappen to XYZ’s WACC if its capital structure were to shift to 40%equity and 60% debt?

wacc increases decreases or stays constant? and why

Answer & Explanation Solved by verified expert
3.8 Ratings (364 Votes)

Step-1:Calculation of existing WACC
Weight Cost
a b a*b
Equity 30% 10% 3.00%
Debt 70% 5% 3.50%
WACC 6.50%
Step-2:Calculation of modified WACC
Weight Cost
a b a*b
Equity 40% 10% 4.00%
Debt 60% 5% 3.00%
WACC 7.00%
So, WACC increases.
Cost of equity is more than cost of debt.
When weight of equity increases,overall WACC increases because increase in weighted cost of equity(4.00%-3.00%=1.00%) is more than decrease in weighted cost of debt(3.50%-3.00%=0.50%).

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Transcribed Image Text

Company XYZ has a target capital structure of 30% equity and 70%debt. Its cost of equity is 10%, and cost of debt is 5%. What wouldhappen to XYZ’s WACC if its capital structure were to shift to 40%equity and 60% debt?wacc increases decreases or stays constant? and why

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