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If a firm increases its use of debt financing, do you think the cost of capital...

If a firm increases its use of debt financing, do you think the cost of capital will go up or down or remains unchanged? (discuss)

Choose one publicly traded stock that has not been chosen by any other students and estimate its expected rate of return according to CAPM. (Best Buy)

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Answer #1

If a Firm increases its use of debt financing the cost of capital will decrease. This is due to the tax deductibility of interest. Due to the benefit of tax deduction the cost of debt and hence the overall cost of capital will decrease.

Samsung Electronics Co- March 2018

Weight of equity = E / (E + D) = 323674.39 / (323674.39 + 15145.65) = 95.53%
Weight of debt = D / (E + D) = 15145.65 / (323674.39 + 15145.65) = 4.47%

Cost of equity= Rf + Beta*(Rm-Rf)

= 2.656%+ 1.03*6%

= 8.836%

Cost of debt = 605.23 / 15145.65 = 4%.

AverageTax =25.47%.

WACC= 95.53%*8.836% + 4.47%*4%* (1-25.47%)

= 8.57%

(Source Gurufocus)

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