Wacky Tobacco, Inc. $($WTI$)$ is a publicly traded corporation headquartered

in California. WTI$$s CFO is calculating its weighted average cost of

capital $($WACC$).$ WTI has obtained capital by selling stock and issuing

bonds. The lenders who bought WTI$$s bonds expect a return of $6$ percent.

WTI$$s stockholders expect a return of $12$ percent on their investment.

The value of the firm is $$500$ million, consisting of $$200$ million in

bonds and $$300$ million in stock. WTI$$s tax rate is $30$ percent.

a$.$ Calculate WTI$$s WACC.

b$.$ Calculate WTI$$s after$-$tax cost of debt

c$.$ Assume WTI sells another $$100$ million in bonds. Recalculate

WTI$$s WACC, assuming all other values for this question remain

the same except the value of the firm, which now equals $$600$

million.

d$.$ Based on a through c above, explain the relationship between

increased leverage and enterprise risk management. In your

answer, it may be helpful to use the example of an airline like

Southwest Airlines, as we discussed in class.