Company XYZ has a target capital structure of 50% equity and 50% debt. Its cost of equity is 6%, and cost of debt is 8% What would happen to XYZ's WACC if its capital structure were to shift to 75% equity and 25% debt? Assume a tax rate is40%.

A. WACC decrease

B. WACC increases

C. WACC remains constant

Option (B) is correct.

Explanation:

WACC = (We * ke) + [Wd * kd * (1 - t) ]

where,

We = Equity

Wd = Debt

ke = cost of equity

kd = cost of debt

t = tax rate

At 50% equity and 50% debt,

WACC = (50% * 6%) + [50% * 8% * (1 - 0.4) ]

= 5.40%

At 75% equity and 25% debt,

WACC = (75% * 6%) + [25% * 8% * (1 - 0.4) ]

= 5.70%

Therefore, there is an increase in the XYZ's WACC if its capital structure were to shift to 75% equity and 25% debt.