Question

A firm wants to create a weighted average cost of capital (WACC) of 10.4 percent. The firm's cost of equity is 14.5 percent and its pre-tax cost of debt is 8.5 percent. The tax rate is 34 percent. What does the debt-equity ratio need to be for the firm to achieve its target WACC? Stiect one: 0 a. 0.51 O b. 0.57 O C. 0.62 d. 0.70 e. 0.86

Answer 1

After-tax cost of debt=8.5*(1-tax rate)

=8.5*(1-0.34)=5.61%

Let debt be $D

Equity be $E

Total=$(D+E)

WACC=Respective cost*Respective weight

10.4=(D*5.61)/(D+E)+(E*14.5)/(D+E)

10.4*(D+E)=5.61D+14.5E

10.4D+10.4E=5.61D+14.5E

D=(14.5-10.4)E/(10.4-5.61)

=0.86E(Approx)

Hence debt-equity ratio=debt/equity

=0.86(Approx).