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Corporate Tax on the WACC of Businesses

A. What are the effects of a corporate tax on the WACC of businesses?

B. Is minimizing WACC by having a largely debt-based capital structure a high risk strategy, given the threat of bankruptcy in an overleveraged business? Explain.

C. What are extraneous factors which impact the ability of a business to radically after its debt-equity mix?

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Please see the attached file.

A) Effects of a corporate tax on the WACC of businesses-
 Weighted Average Cost Of Capital - WACC - A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation.
WACC is calculated by multiplying the cost of each capital component by its proportional weight and then summing:

Where:
Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V = E + D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate

 Broadly speaking, a company's assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it finances.

 A firm's WACC is the overall required return ...

Solution Summary

Is minimizing WACC by having a largely debt-based capital structure a high risk strategy, given the threat of bankruptcy in an overleveraged business? Explain.

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