Chartered Financial Analyst Level 2

Explanation

When a company acquires another company with a similar structure and finances the acquisition entirely with new equity, the WACC (Weighted Average Cost of Capital) would most likely increase.

Key Reasons:

1. Capital Structure Change: The acquisition is financed entirely with new equity, which increases the proportion of equity in the capital structure. Since equity is typically more expensive than debt, this shift increases the overall cost of capital.

2. Cost Components Remain Unchanged: The problem states that both the cost of debt and cost of equity remain unchanged. However, the weights in the WACC calculation change:

   • Equity weight increases
   • Debt weight decreases (relative to the larger capital base)

3. WACC Formula: [ WACC = (E/V) \times r_e + (D/V) \times r_d \times (1 - t) ] Where:

   • E = Market value of equity
   • D = Market value of debt
   • V = E + D (Total value)
   • r_e = Cost of equity
   • r_d = Cost of debt
   • t = Tax rate

4. Impact Analysis:

   • Since r_e > r_d (equity is more expensive than debt)
   • And the equity weight (E/V) increases
   • The overall WACC will increase

Therefore, the correct answer is C - increase.