# Question

Revtek, Inc., has an equity cost of capital of 12% and a debt cost of capital of 6%. Revtek maintains a constant debt-equity ratio of 0.5, and its tax rate is 35%.

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%?

c. Now suppose investors pay tax rates of 40% on interest income and 15% 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.

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%?

c. Now suppose investors pay tax rates of 40% on interest income and 15% 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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