The company’s CEO has stated if the company increases the amount of long term debt so the capital structure will be 60% debt and 40% equity, this will lower its WACC. Explain and defend why you agree or disagree.

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I disagree with the CEO’s assertion that growing long run debt will decrease the corporate’s WACC. It’s because whereas it’s true that growing debt can scale back the general value of capital, this comes at a price of added danger to shareholders. With an elevated stage of leverage, there are extra dangers by way of credit standing downgrade and potential default if rates of interest or market circumstances take a flip for the more serious. Furthermore, including an excessive amount of debt might additionally make the corporate much less engaging for traders as their returns will not be ample to compensate for taking up extra danger.

Moreover, one ought to contemplate taxes when contemplating any change in capital construction as effectively as a result of larger ranges of debt will result in extra tax deductions which could partially offset the rise in value because of borrowing cash. All these elements must be considered earlier than making any modifications which suggests it’s extremely unlikely that merely growing long run debt would lower WACC until accomplished fastidiously and after taking all externalities under consideration first.