b6d83f54_l_Review_Flashcards___Cram_com___using_dividend_growth_model__
C is correct. Even though the beta increases in the next scenario, only 70% of the capital is equity and the rest is debt, with an after-tax cost of capital of 7.5%. Thus, moving to this debt structure would lower Datacomp's weighted-average cost of capital. Present WACC = 6 + .95 (16-6) = 15.5% Proposed WACC Cost of Equity = 6 + 1.05 (16 - 6) = 16.5% WACC = 0.7(16.5) + .30(7.5) = 11.55 + 2.25 = 13.8%
Datacomp Industries, which has no current debt, has a beta of .95 for its common stock. Management is considering a change in the capital structure to 30% debt and 70% equity. This change would increase the beta on the stock to 1.05, and the after-tax cost of debt will be 7.5%. The expected return on equity is 16%, and the risk-free rate is 6%. Should Datacomp's management proceed with the capital structure change? A- No, because the cost of equity capital will increase B- Yes, because the cost of equity capital will decrease C- Yes, because the weighted-average cost of capital will decrease D- No, because the weighted-average cost of capital will increase
Final Review Flashcards - Cram.com