Fama’s Llamas has a weighted average cost of capital of 9.2 percent. The company

Question

Fama’s Llamas has a weighted average cost of capital of 9.2 percent. The company’s cost of equity is 12 percent, and its pretax cost of debt is 7.2 percent. The tax rate is 40 percent. What is the company’s target debtequity ratio? (Do not round intermediate calculations and round your final answer to 4 decimal places. (e.g., 32.1616))

Fama’s Llamas has a weighted average cost of capital of 9.2 percent. The company’s cost of equity is 12 percent, and its pretax cost of debt is 7.2 percent. The tax rate is 40 percent. What is the company’s target debtequity ratio? (Do not round intermediate calculations and round your final answer to 4 decimal places. (e.g., 32.1616))

Explanation / Answer

WACC = Wd×Rd×(1-t)+ We×Ke

W is weights of respective portfolios

R is return on respective portfolios

Wd+We = 1

0.092 = Wd×0.072×(1-40%)+(1-Wd)×0.12

0.092 = Wd×0.0432+0.12-0.12×Wd

Wd = 0.3646

We = 0.6354

Debt equity ratio:

= 0.3646÷0.6354

= 0.5738

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