Question

Fama's llamas has a wacc of 10.7 percent. the company's cost of equity is 14 percent, and its pretax cost of debt is 8.5 percent. the tax rate is 35 percent. what is the company's target debt–equity ratio? (do not round intermediate calculations and round your answer to 4 decimal places,

e.g., 32.1616.) debt–equity ratio 0.3946 rev: 07_08_2017_qc_cs-95053

Answer 1

WACC is calculated as –

WACC = (Weight of common stock X Cost of common stock) + (Weight of debt X After tax cost of debt)

WACC = 10.7 %

Let the weight of debt be x %, so the weight of equity = 1 - x %

10.7 % = ((1-x%) * 14%) + ( x % *(1-.35)*8.5%)

10.7% = (14 % - .14x) + (5.525x%)

x % = 38.94% which is weight of debt

Weight of equity = 1 - 38.94 %

Weight of equity = 61.06%

Debt - equity ratio = debt / equity = 38.94 % / 61.06 %

Debt - equity ratio = 63.77 %