Question

Please show formulas and calculations and not just results and numbers, and explain rationale for answers.

Equity Lighting Corporation wishes to explore the effect on its cost of capital of the rate at which the company pays taxes. The firm wishes to maintain a capital structure of 30% debt, 10% preference shares and 60% ordinary shares. Considering Equity’s risk profile, shareholders expect a return of 14% on their investment, the cost of preference shares financing is 9% and the before-tax cost of debt financing is 11%.

a. Calculate the WACC given the three different tax rate assumptions given below

1. Tax rate = 40%

2. Tax rate = 30%

3. Tax rate = 25%

b. Describe the relationship between changes in the rate of taxation and the WACC.

Answer 1

Answer is given below