Assume that with a capital structure of 10% debt and 90% equity the cost of debt is 10% and cost of equity is 14%. The tax rate is 40%. The current value of the business is $ 500,000. The finance manager of the company is recommending a change of capital structure to 80% debt and 20% equity. He states that at effective cost of debt of 10% the increase of debt in capital structure would always increase the value of the firm.

He further adds that the cost of equity will remain the same at any level of debt as it should not only increase the earnings but also decrease the beta of the company's stock. He also stated that floatation cost is not high in the case of debt financing as compared to equity financing.

Required:

(1)Calculate the WACC for the ccompany.

(2)Do you agree with the recommendation and reasoning of the finance manager? Give three reasons as to why you agree with the reasoning?

(3)In case you don't agree give three reasons in support of your response.

(4)Is finance manager correct about his statement related to floatation costs? Explain in less than 5 lines.