A study showed that banks weighted average cost of capital (WACC) is independent of leverage.

(a) Assume a risk-free rate of 1.0% and a market risk premium of 8%. ABC Bank has an assets to equity ratio of 16.0 (i.e., D+E/E = 16.0) and an equity beta equal to 1.1. What is ABCs WACC assuming study is correct? Ignore taxes and assume ABC's debt is risk free.

(b) If ABC Bank were to issue new shares of equity to cut its assets to equity ratio in half, what is its new expected return on equity and new WACC?

(c) Repeat parts a and b assuming that ABC Bank's interest payments on debt are tax deductible and the bank pays 26% in corporate taxes.