8. One of your new employees notes that your debt has a lower cost of capital...

8. One of your new employees notes that your debt has a lower cost of capital (4%) than your equity (13%). So, he suggests that the firm swap its capital structure from 31% debt and 69% equity to 69% debt and 31% equity instead. He estimates that after the swap, your cost of equity would be 18%.
a. What would be your new cost of debt? Make your calculations based on your firm's pre-tax WACC.
b. Have you lowered your overall cost of capital?

Expert Solution

a) Cost of new debt = cost of debt * weight

= 4% * 0.69

= 2.76% Answer

b) Cost of capital new = Weighted average of cost

= 4% * 0.69 + 18% * 0.31

= 4% + 5.58%

= 8.34% Answer

Cost of capital old = Weighted average of cost

= 4% * 0.31 + 13% * 0.69

= 1.24% + 8.97%

= 10.21%

Thus wacc is lowered in new structure.

jeff jeffy answered 2 years ago

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