Textbook Question on cost of capital
Your firm has a debt-equity ratio of .60. Your cost of equity is 11% and your after-tax cost of debt is 7%. What will your cost of equity be if the target capital structure becomes a 50/50 mix of debt and equity?
Solutions given: WACC = [(1.0 / 1.6) x .11] + [(.6 / 1.6) x .07] = .095; .095 = .5Re + (.5 x .07); Re = 12%
Isn’t the above solution totally wrong? Since WACC is always going to change with a change in capital structure, in the presence of taxes.
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