Nailah Mablevi is an equity analyst who covers the entertainment industry for Kwame Capital Partners, a major global asset manager. Kwame owns a significant position, with a large unrealized capital gain, in Mosi Broadcast Group (MBG). On a recent conference call,
MBG’s management stated that they plan to increase the proportion of debt in the company’s capital structure. Mablevi is concerned that any changes in MBG’s capital structure will negatively affect the value of Kwame’s investment.
To evaluate the potential impact of such a capital structure change on Kwame’s investment, she gathers the information about MBG given in Exhibit 1.

Holding operating earnings constant, an increase in the marginal tax rate to 40% would:

A. result in a lower cost of debt capital.

B. result in a higher cost of debt capital.

C. not affect the company’s cost of capital.

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EXHIBIT 1: Current Selected Financial Information on MBG Yield to maturity on debt Market value of debt Number of shares of common stock Market price per share of common stock Cost of capital if all equity-financed Marginal tax rate 8.00% USD100 million 10 million USD30 10.3% 35%