Tack Laser Ltd., a high-end medical equipment manufacturer, is trying to decide whether to revise its target capital structure. Currently, it targets a structure with 40% debt, but it is considering a target capital structure with 60% debt. Tack Laser currently has an 8% after-tax cost of debt and a 14% cost of common stock. The company does not have any other stock or debt outstanding.

a. What is Tack Laser’s current WACC?

b. Assuming that its cost of debt and equity remain unchanged, what will be Laser Tack’s WACC under the revised target capital structure?

c. Do you think that shareholders are affected by the increase in debt to 60%? If so, how are they affected? Are their common stock claims riskier now?

d. Suppose that in response to the increase in debt, Tack Laser’s shareholders increase their required return so that the cost of common equity is 18%. What will its new WACC be in this case? Is it still advisable for the management to revise the target capital structure?

e. Based on your answers to parts a to d, explain the tradeoff between financing with debt versus equity.