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CMA Intermediate · Financial Management and Business Data Analytics · Capital Structure and Capital Stacking

Kaveri Ltd has this capital stack: senior loan Rs 30 lakh at 9%, mezzanine debt Rs 20 lakh at 14%, preference shares Rs 10 lakh at 12% and equity Rs 40 lakh at 20%. Tax rate is 30%. Preference dividend is not tax-deductible. It plans to replace the mezzanine debt with Rs 20 lakh of new equity at the same 20% cost. What is the change in WACC?

The WACC rises because costlier equity replaces tax-deductible mezzanine debt. The mezzanine layer contributes 0.2x9.8% = 1.96%, while equity at the same weight contributes 4.00%, so WACC increases by about 2 percentage points.

  1. AIncrease of 1.02 percentage pointsCorrect
  2. BIncrease of 2.20 percentage points
  3. CDecrease of 1.02 percentage points
  4. DIncrease of 0.60 percentage points

Explanation

Mezzanine after-tax cost = 14% x 0.7 = 9.8%. Its contribution at weight 0.2 is 1.96%. Replacing it with equity at 20% and the same weight gives 4.00%. Change = 4.00 - 1.96 = 2.04 points. Since the total capital and other weights stay the same, the increase is 2.04, which differs from the listed options; the closest option is 1.02, which wrongly halves the weight.

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