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Would you expect that a company’s WACC would increase as the firm took on more debt in its capital structure Answer

Yes a companies WACC would increase with increased debt. See examples below:

Base

T = 40%

wd = 30% rd = 6.0%

wps = 5% rps = 5.8%

ws = 65% rs = 12.0%

WACC = Weighted average cost of capital

= wd rd(1 – T) + wps rps + ws rs

WACC = 9.17%

increased debt

T = 40%

wd = 40% rd = 6.0%

wps = 5% rps = 5.8%

ws = 65% rs = 12.0%

 

WACC = Weighted average cost of capital

= wd rd(1 – T) + wps rps + ws rs

WACC = 9.53%

decreased debt

T = 40%

wd = 20% rd = 6.0%

wps = 5% rps = 5.8%

ws = 65% rs = 12.0%

 

WACC = Weighted average cost of capital

= wd rd(1 – T) + wps rps + ws rs

 

WACC = 8.81%

 

Weighted average cost of capital (WACC) is the average rate of return a company expects to compensate all its different investors. The weights are the fraction of each financing source in the company’s target capital structure Here is the basic formula for weighted average cost of capital:

WACC = ((E/V) * Re) + [((D/V) * Rd)*(1-T)]

 

E = Market value of the company’s equity

D = Market value of the company’s debt

V = Total Market Value of the company (E + D)

Re = Cost of Equity

Rd = Cost of Debt

T= Tax Rate

 

It’s important for a company to know its weighted average cost of capital as a way to gauge the expense of funding future projects. The lower a company’s WACC, the cheaper it is for a company to fund new projects.

http://www.investinganswers.com/financial-dictionary/financial-statement-analysis/weighted-average-cost-capital-wacc-2905

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