Please teach me how to answer the following questions:

1. The current weighted average cost of capital (WACC) for Taco Loco is 10%. The company announced a debt offering that raises the WACC to 13%. The most likely conclusion is that for Taco Loco

Responses

A. The company's prospects are improving.

B. Equity financing is cheaper than debt financing.

C. The company's debt/equity ratio has moved beyond the optimal range.

2. Frida Williams is an equity analyst who covers the entertainment industry for WhiteRock, a major global asset manager. WhiteRock owns a significant position with a large unrealized capital gain in Postive Semi Conductors (PSC). On a recent conference call, PSC's management states that they plan to increase the proportion of debt in the company's capital structure. Williams is concerned that any changes in PSC's capital structure will negatively affect the value of WhiteRock's investment. To evaluate the potential impact of such a capital structure change on WhiteRocks's investment, she gathers the following information about PSC:

• Yield to maturity on debt: 8.00%
• Market value of debt: $100million
• Number of shares of common stock: 10million
• Market price per share of common stock: $30
• Cost of capital if all equity financed: 10.3%
• Marginal tax rate: 35%

Williams expects that an increase in PSC's financial leverage will increase its costs of debt and equity. Based on an examination of similar companies in PSC's industry, Williams estimates PSC's cost of debt and cost of equity at various debt-to-total capital ratios.

• Debt-to-Total Capital Ratio (%): 20, Cost of Debt (%): 7.7, Cost of Equity (%): 12.5
• Debt-to-Total Capital Ratio (%): 30, Cost of Debt (%): 8.4, Cost of Equity (%): 13.0
• Debt-to-Total Capital Ratio (%): 40, Cost of Debt (%): 9.3, Cost of Equity (%): 14.0
• Debt-to-Total Capital Ratio (%): 50, Cost of Debt (%): 10.4, Cost of Equity (%): 16.0

Holding operating earnings constant, an increase in the marginal tax rate to 40% would

Responses

A. Result in a higher cost of debt capital

B. Not affect the company's cost of capital

C. Result in a lower cost of debt capital