How would each of the following scenarios affect a firm’s cost of debt, rd 1 − T ; its cost of equity, rs; and its WACC? Indicate with a plus , a minus − , or a zero 0 if the factor would raise, lower, or have an indeterminate effect on the item in question. Assume for each answer that other things are held constant even though in some instances this would probably not be true. Be prepared to justify your answer but recognize that several of the parts have no single correct answer. These questions are designed to stimulate thought and discussion.

Effect on rd 1 − T rs WACC

a. The corporate tax rate is lowered. ____________ ____________ ____________

b. The Federal Reserve tightens credit. ____________ ____________ ____________

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

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

e. The firm doubles the amount of capital it raises during the year. ____________ ____________ ____________

f. The firm expands into a risky new area. ____________ ____________ ____________ g. The firm merges with another firm whose earnings are countercyclical both to those of the first firm and to the stock market. ____________ ____________ ____________ h. The stock market falls drastically, and the firm’s stock price falls along with the rest. ____________ ____________ ____________ i. Investors become more risk averse. ____________ ____________ ____________ j. The firm is an electric utility with a large investment in nuclear plants. Several states are considering a ban on nuclear power generation. ____________ ____________ ____________ AppendixLO1