Fama’s Llamas has a weighted average cost of capital of 9.8 percent. The company
ID: 2764848 • Letter: F
Question
Fama’s Llamas has a weighted average cost of capital of 9.8 percent. The company’s cost of equity is 12 percent, and its pretax cost of debt is 7.8 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 9.8 percent. The company’s cost of equity is 12 percent, and its pretax cost of debt is 7.8 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
Let the proportion of equity in the capital structure be P. Then the proportion of debt in the total capital structure is ( 1-P)
0.12 x P + 0.078 x ( 1-0.40) x ( 1-P) = 0.098
0.12P - 0.0468P = 0.098 - 0.0468 or P = 0.0512 / 0.0732 = 0.70
Equity is 70%, and Debt is 30%
Target debt-equity ratio = 30 : 70 or 0.43
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