P14-11 Finding the Target Capital Structure [LO3] Fama\'s Llamas has a weighted
ID: 2796260 • Letter: P
Question
P14-11 Finding the Target Capital Structure [LO3]
Fama's Llamas has a weighted average cost of capital of 11 percent. The company's cost of equity is 17 percent, and its pretax cost of debt is 8 percent. The tax rate is 32 percent. What is the company's target debt-equity ratio? (Do not round your intermediate calculations.)
Fama's Llamas has a weighted average cost of capital of 11 percent. The company's cost of equity is 17 percent, and its pretax cost of debt is 8 percent. The tax rate is 32 percent. What is the company's target debt-equity ratio? (Do not round your intermediate calculations.)
Explanation / Answer
Let debt be $x
Equity be $y
Total=$(x+y)
After tax cost of debt=8(1-0.32)=5.44%
WACC=Respective costs*Respective weights
0.11=(x/(x+y)*0.0544)+(y/(x+y)*0.17)
0.11(x+y)=0.0544x+0.17y
0.11x+0.11y=0.0544x+0.17y
x=(0.17-0.11)y/(0.11-0.0544)
=1.08y
Hence target debt-equity ratio-1.08(Approx)
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