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Burnham Brothers Inc

Finance

Burnham Brothers Inc. has no retained earnings since it has always paid out all of its earnings as dividends. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC? a. The company's beta increases. b. The flotation costs associated with issuing preferred stock increase. C. The market risk premium increases. d. The tax rate increases. e. Expected inflation increases.

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The tax rate increases

Cost of debt = Yield to maturity (1 - tax rate)

Cost of debt is a component of WACC. The interest paid on debt is tax deductible. As you can see from the formula, cost of debt will decrease when tax rates increase. Since cost of debt decrease, WACC will also decrease.

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