Question

Which of the following statements about the cost of capital is incorrect? Select one: a. A company's target capital structure affects its weighted average cost of capital. b. Weighted average cost of capital calculations should be based on the after-tax-costs of all the individual capital components. c. If a company's tax rate increases, then, all else equal, its weighted average cost of capital will increase. d. The cost of retained earnings is equal to the return stockholders could earn on alternative investments of equal risk. e. Flotation costs can increase the cost of preferred stock.

Answer 1

Answer:

c. If a company's tax rate increases, then, all else equal, its weighted average cost of capital will increase.

Explanation:

We will analize based on the WACC formula:

$WACC = K_e(\frac{E}{E+D}) + K_d(1-t)(\frac{D}{E+D})$

(C) Incorrect, if the tax-rate increase, notice the cost of debt tax-shield will be higher, therefore it will generate a lower WACC

asumming a debt cost of 10%

if the tax-rate is 20%  10% ( 1 - 20%) = 8%

if the tax-rate is 50%  10% ( 1 - 50%) =5%

the cost of debt is lower, thus the WACC will be lower to.