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Rolm Telephone Corp currently has a cost of debt of 5.5%, a cost of equity of...

Rolm Telephone Corp currently has a cost of debt of 5.5%, a cost of equity of 13%, and a marginal tax rate of 28%. Explain the impact on Rolm’s WACC and NPV in the two following scenarios. (I haven’t given you the weights and there is no need to actually calculate the WACC.) (There are several parts to this question; 1 sentence for each item.) Scenario 1: Congress will passes a special “Telecomm Tax” that will raise their marginal tax rate to 34%. Impact on WACC: Impact on NPV: Scenario 2: Recent litigation has dramatically increased Rolm’s perceived risk and Rolm’s beta has increased. Impact on WACC: Impact on NPV:

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Answer #1

Case 1) when tax rate is increased

Impact on wacc: wacc will be decreased as cost of debt component in wacc will decrease because of increase in tax rate we will get more tax sheild on interest expense

Impact on npv: Npv will decrease because increase in tax rate will reduce after tax cash flows even wacc is lowerd because reduction in cash flows has more impact than decrease in wacc

Case 2) increase in perception of risk

Impact on wacc: wacc will increase because cost of equity will increase as risk perception about risk increased

Impact on npv: Npv will decrease as cost of capital is increased so discount rate is increased so Npv will decrease

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