Gator Fabrics Inc.currently has zero debt .It is a zero growth company,and additional firm data are shown below.Now the company is considering using some debt,moving to the new capital structure indicated below.The money raised would be used to repurchase stock at the current price.It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat,as indicated below.If this plan were carried out,by how much would the WACC change,i.e. ,what is WACC_Old - WACC_New? Do not round your intermediate calculations.

Question

Quizplus · Accepted Answer

First, we need to calculate the current WACC using the formula: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc) where: E = Market value of equity D = Market value of debt V = Total value of the firm (E + D) Re = Cost of equity Rd = Cost of debt Tc = Corporate tax rate Given that the company currently has zero debt, the WACC is simply equal to the cost of equity: WACCold = Re = 11% Next, we need to calculate the new WACC based on the proposed capital structure. The new capital structure is: Debt = 30% of total value Equity = 70% of total value We are also told that the required rate of return on equity will increase following the issuance of debt. Let's assume that the new cost of equity will be 12%. We can then solve for the new cost of debt using the current and proposed WACC: WACCold = (E/V) * Re => 0.11 = (0.7) * Re => Re = 0.11 / 0.7 = 15.71% WACCnew = (E/V) * Re + (D/V) * Rd * (1 - Tc) => 0.15 = (0.7) * 0.12 + (0.3) * Rd * (1 - 0.35) => Rd = 5.77% WACCnew = (0.7) * 0.12 + (0.3) * 0.0577 * (1 - 0.35) = 11.00% Finally, we can calculate the change in WACC: WACC_Old - WACC_New = 0.11 - 0.11 = 0.00 = 0.00% The change in WACC is zero, so the best answer is B.