Equity Lightning Corp. wishes to explore the effect on its cost of capital of the rate at which the company pays taxes. The firm wishes to maintain a capital structure of 30% debt, 10% preferred stock, and 60% common stock. The cost of financing using retained earnings is 14%, the cost of preferred stock financing is 9%, and the before-tax cost of debt financing is 11%. Calculate the weighted average cost of capital (WACC) given the following tax rate assumptions: (1) tax rate=40%, (2) tax rate=35%, (3) tax rate= 25%, describe the effect of tax rate on WACC?

A.(1)11.28%

(2) 11.45%

(3) 11.78%

As the tax rate decreases, the WACC increases due to the reduced tax shield from the tax-deductible interest on debt.

B.(1)11.28%

(2)11.45%

(3)11.78%

As the tax rate increases, the WACC increases due to the reduced tax shield from the tax-deductible interest on debt.

C.(1)12.82%

(2)13.35%

(3)13.88%

As the tax rate decreases, the WACC increases due to the reduced tax shield from the tax-deductible interest on debt.

D.(1)11.28%

(2)11.45%

(3)11.78%

As the tax rate decreases, the WACC decreases due to the reduced tax expense.