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CS Executive · Corporate Accounting and Financial Management · Operational Approach to Financial Decision

Mehta Ltd has equity of Rs 8,00,000 at cost 14% and 10% debentures of Rs 2,00,000. Tax rate is 30%. If the company raises its debt share to 40% of total capital (keeping the same costs), by how much does WACC change?

WACC falls by 1.4 percentage points, from 12.6% to 11.2%. Shifting 20% of capital from 14% equity to 7% post-tax debt lowers the average by 0.2 x (14 - 7) = 1.4 points, assuming costs stay constant.

  1. AFalls by 1.4 percentage points
  2. BFalls by 0.84 percentage pointsCorrect
  3. CRises by 1.4 percentage points
  4. DFalls by 2.1 percentage points

Explanation

After-tax debt cost = 7%. Initial WACC = 0.8 x 14 + 0.2 x 7 = 11.2 + 1.4 = 12.6%. New WACC = 0.6 x 14 + 0.4 x 7 = 8.4 + 2.8 = 11.2%. Change = 1.4 points fall. Hence the fall is 1.4 points; the 0.84 figure wrongly uses only the equity weight shift.

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