In Lecture 1 Part 4 we discuss the impact of risk (VUCA) factors on the cost of debt and equity. We cover these two aspects of WACC separately. For example, we introduce a ratings model for pricing project/firm risk into the cost of debt. We then introduce a CAPM model for pricing risk into the cost of equity. Yet, in the real world, the same company can be expected to have its capital stack to include both debt and equity. In addition, in the real world, companies change their mix of capital over time, sometimes increasing debt share in total capital stack and at other times increasing equity share. Considering the U.S. economy is moving towards the post-COVID19 environment of higher interest rates (higher cost of debt), what effects of such a move would you expect to occur for:

1. Companies capital stacks pivoting to more debt or more equity shares over the next 2-3 years?

2. Companies overall WACC? Hint: consider the effect of higher interest rates on both debt and equity costs.

3. Companies willingness to borrow funds (increase share of debt) to buy back shares (decrease share of equity)?

4. Companies willingness to undertake highly risky, radical innovation-focused investments, generally associated with higher payoffs, but also much higher risks of failure?

Explain your answers.