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    Impact on WACC

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    A firm has determined its cost of each source of capital and optimal capital structure, which is composed of the following sources and target market value proportions:

    Source of Capital Target Market Proportions After-Tax Cost

    Long-term debt 45% 5%
    Preferred stock 10 14
    Common stock equity 45 22

    If the firm were to shift toward a more leveraged capital structure (i.e., a greater percentage of debt in the capital structure), the weighted average cost of capital would? Explain your answer.

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    Solution Preview

    The answer is it will increase because an optimal capital structure implies that the Weighted Average Cost of Capital (WACC) is the minimum. We calculate the WACC at various capital structures and where the WACC is the minimum that ...

    Solution Summary

    The solution explains the impact on the Weighted Average Cost of Capital (WACC) if the firm moves to a more leveraged capital structure.