Fama\'s Llamas has a weighted average cost of capital of 13 percent. The company
ID: 2619647 • Letter: F
Question
Fama's Llamas has a weighted average cost of capital of 13 percent. The company's cost of equity is 17.5 percent, and its pretax cost of debt is 8 percent. The tax rate is 34 percent. What is the company's target debt-equity ratio? (Do not round your intermediate calculations.)
0.9
0.5538
0.5829
0.6062
0.612
Fama's Llamas has a weighted average cost of capital of 13 percent. The company's cost of equity is 17.5 percent, and its pretax cost of debt is 8 percent. The tax rate is 34 percent. What is the company's target debt-equity ratio? (Do not round your intermediate calculations.)
Explanation / Answer
After-tax cost of debt=8(1-tax rate)
=8(1-0.34)=5.28%
Let debt be $x
Equity be $y
Total=$(x+y)
WACC=Respective costs*Respective weights
13=(5.28x/(x+y)+(17.5y/(x+y)
13(x+y)=5.28+17.5y
13x+13y=5.28+17.5y
x=(17.5-13)y/(13-5.28)
=0.5829y
Hence debt-equity ratio=Debt/Equity
=0.5829(Approx).
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