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Tapley Inc. currently has total capital equal to $7 million, has zero debt, is in the 40% federal-plus-state tax bracket, has a net income of $3 million, and pays out 40% of its earnings as dividends. Net income is expected to grow at a constant rate of 5% per year, 470,000 shares of stock are outstanding, and the current WACC is 12.70%.

The company is considering a recapitalization where it will issue $2 million in debt and use the proceeds to repurchase stock. Investment bankers have estimated that if the company goes through with the recapitalization, its before-tax cost of debt will be 9% and its cost of equity will rise to 16.5%.