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Thompson Products has seen its marginal tax rate increase from 28% to 34% over the last two years and believes the change is permanent The effects of this change on Thompson’s current WACC and on its financial leverage over time are most likely a(n):

A increase in one and a decrease in the other.

An increase in the tax rate will reduce Thompsons after-tax cost of debt (other things equal) and therefore reduce its WACC. With a relatively lower cost of debt the firm will likely change its capital structure to include more debt and less equity (i.e., to increase its financial leverage).

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