TSL has 2.5 million shares outstanding at $20 per share. It has $50 million debt....
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TSL has 2.5 million shares outstanding at $20 per share. It has $50 million debt. Its debt cost of capital is 9%, and its equity cost of capital is 18%. Suppose the company decides to move to a more conservative debt policy. A year later, its D/E ratio is down to 1/2. The cost of debt has dropped to 8.5%. The companys business risk, opportunity cost of capital, and tax rate have not changed.
a. What is the likely reason that the cost of debt decreases after its D/E ratio is down to 1/2?
b. What is the companys new WACC when its D/E ratio is 1/2?
c. If the companys business risk and opportunity cost of capital have changed, does WACC remain the same as what you calculated in (b)? Why or why not?
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