HP and Dell are companies in the exact same business. They both used to have the same capital structure with a debt-to-equity ratio of 1/19. Recently, however, Dell hired many investment bankers and consultants at great expense, and decided to change its debt-to-equity ratio to 1/5. HP figures that they will copy Dell, and move their debt-to-equity ratio to 1/5 as well.

HP doesnt want to pay for the bankers and consultants that Dell used. Thus, HP relies on you to help them understand the transition.

Assume the following: HP used to have a cost of equity of 20%. Assume that regardless of its capital structure, HPs cost of debt is 3%. The change in D/E is expected to be permanent. Further, HPs tax rate is 30%.

[Step 1: de-levering] Find the cost of unlevered equity for HP.

A.16.35%

B.19.00%

C.19.15%

D.22.38%

[Step 2: Re-levering] Find the cost of levered equity for HP under the new capital structure (i.e. the debt-to-equity ratio of 1/5).

A.19.00%

B.17.48%

C.19.15%

D.22.38%

What is HPs new WACC?

A.19.00%

B.17.48%

C.19.15%

D.22.38%