Economics · Financial Management
A large infrastructure company, 'Apex Buildcon', is planning a massive project requiring an investment of Rs. 1,000,000,000. Currently, the company can borrow debt at 10% interest. The market risk-free rate is 7%, market risk premium is 6%, and the company's equity beta is 1.5. The baseline statutory corporate tax rate is 25%, and the target Debt-to-Equity ratio is 1:1. Based on Weighted Average Cost of Capital (WACC) theory, if the government suddenly announces a tax holiday for infrastructure projects (reducing the tax rate to 0%), what would be the most significant impact on the company's WACC?
Verified Solution4 OptionsUpdated: October 2026👁️1 View
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- 1The cost of debt will become higher than the cost of equity because debt no longer has a tax advantage.
- 2The WACC will remain completely unchanged because the cost of equity will decrease to compensate for the lack of a tax shield.
- 3The WACC will increase because the tax shield on interest disappears, making the cost of debt higher on an after-tax basis.✓
- 4The WACC will decrease because the company no longer has to pay taxes, making the project more feasible.
Correct answer
The WACC will increase because the tax shield on interest disappears, making the cost of debt higher on an after-tax basis.
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