Question

Kountry Kitchen has a cost of quity of 11.2 percent, a pretax cost of debt of 5.8 percent, and the tax rate is 39 percent. If the company's WACC is 8.77 percent, what is its debt-equity ratio?

Answer 1

Answer 1
let us assume weight of debtbe x and weight of equity be 1-x
After tax cost of debt =pretax cost of debt * (1-Tax rate) = 5.8% * (1-0.39) = 3.538%
WACC = [Cost of equity *Weight of equity] + [Cost of debt * Weight of debt]
8.77% = [11.2% * (1-x)] +[3.538% * x]
8.77% = 11.2% - 11.2%x +3.538%x
8.77% = 11.2% - 7.662%x
2.43% = 7.662%x
x = 0.317
Weight of debt = 0.317
Weight of equity = 1 - 0.317=0.683
Debt equity ratio =debt / equity = 0.317 / 0.683 = 0.464