Question

Fama’s Llamas has a weighted average cost of capital of 8.7 percent. The company’s cost of equity is 12.3 percent, and its cost of debt is 6.9 percent. The tax rate is 22 percent. What is the company’s debt-equity ratio? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

Answer 1

The WACC is 8.7%

weight of debt * cost of debt* (1 -tax rate) + weight of equity * cost of equity

Let the cost weight of debt be x/100

so weight of equity will be (100 - x)/100

8.7 = X/100 * 6.9 * 0.78 + (100 - X)100 * 12.3

870 = 5.38X + (100 - X)*12.3

870 = 5.38X + 1230 - 12.3X

6.92X = 360

X = 52.0231%

SO, weight of debt = 52.0231%

weight of equity = 47.9769%

SO, debt/equity is =1.0843

= 1.0843 (rounded off to four decimal places)