Revtek, Inc., has an equity cost of capital of 12.6% and a debt cost of capital of 6.3%. Revtek maintains a constant debt-equity ratio of 0.5, and its tax rate is 34%.
a. What is Revtek’s WACC given its current debt-equity ratio?
b. Assuming no personal taxes, how will Revtek’s WACC change if it increases its debt-equity ratio to 2 and its debt cost of capital remains at 6.3%?
c. Now suppose an investors pays tax rates of 32% on interest income and 13% on income from equity. How will Revtek’s WACC change if it increases its debt-equity ratio to 2 in this case?
d. Provide an intuitive explanation for the difference in your answers to parts (b) and (c).
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