Medzyme Pharmaceuticals has maintained a 50–50 D-E mix for capital investments. Equity capital has cost 11%; however, debt capital that has historically cost 9% is now 20% higher than that. If Medzyme does not want to exceed its historical weighted average cost of capital (WACC), and it is forced to go to a D-E mix of 75–25, the maximum acceptable cost of equity capital is closest to: (choose one)
(a) 7.6%
(b) 9.2%
(c) 9.8%
(d ) 10.9%
Historical WACC = 0.5(11%) + 0.5(9%) = 10%
Let x = cost of equity capital
WACC = (equity fraction)(cost of equity) + (fraction of debt)(cost of debt)
10% = 0.25(x) + 0.75[9%(1.2)]
x = (10 - 8.1)/0.25
= 7.6%
Answer is (a) 7.6%
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