CALMA, GAZELLE ANNE A.

BSA-3A

Probable Effect on
kd(1 – T) ke WACC

a. The corporate tax rate is lowered. + 0 +

Justification: The decrease in tax rate increases the cost of debt and hence it increases the
WACC.

b. The BSP Reserve tightens credit. + + +

Justification: This scenario will positively affect cost of debt, cost of equity and WACC.

c. The firm uses more debt; that is, it increases

its debt ratio. + + 0
Justification: Increase in debt ratio somehow effect the cost of debt and cost of equity.

d. The dividend payout ratio is increased. 0 0 0

Justification: The increase in dividend payout ratio does not affect the cost of debt, cost of equity
and WACC.

e. The firm doubles the amount of capital it raises

during the year. 0 or + 0 or + 0 or +
Justification: It may change or may not bring any change. Thus, there is equal chance.

f. The firm expands into a risky new area. + + +

Justification: The raising of capital through risky project will have higher cost of capital than safer
project.

g. The firm merges with another firm whose earnings

are countercyclical both to those of the first firm and
to the stock market. - - -
Justification: This may negatively affect the cost of debt, cost of equity and WACC.

h. The stock market falls drastically, and the firm’s stock

price falls along with the rest. 0 + +
Justification: The drastic fall in stock market does not affect the debt but increases both cost of debt
and WACC.

i. Investors become more risk-averse. + + +

Justification: Risk affects the cost of debt, cost of equity and overall cost of the firm positively.

j. The firm is an electric utility with a large investment in

nuclear plants. Several states are considering a ban
on nuclear power generation. + + +
Justification: The large investment in nuclear power generation is risky. Risky investments raise cost
of debt, cost of equity and WACC.