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A company is going to take on a project using a mix of equity and debt finance in an economy where the corporation tax rate is 30%.
Assuming perfect markets, other than tax, which of the following statements is true about the project if low levels of debt are introduced to the company’s capital structure?answer : ?e > ?a; WACC < Cost of equity calculated using ?a; WACC < Cost of equity calculated using ?e
sir can u plz explain this in very simple words 🙂
The risk of equity, and therefore the equity beta, increases with higher gearing and is therefore higher than the asset beta (which is the risk with no gearing).
The WACC will always be lower than the cost of equity because included in the weighting is the cost of debt which is always lower than the cost of equity.
I explain all of this, with examples, in my free lectures.
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