Question

Fama's Llamas has a weighted average cost of capital of 9 percent. The company's cost of equity is 15 percent, and its pretax cost of debt is 10 percent. The tax rate is 36 percent. What is the company's target debt-equity ratio?

**(Do not round intermediate calculations and round your
final answer to 2 decimal places. For example, 1.2345 should be
entered as 1.23.)**

Answer #1

WACC = Wd*kd + We*ke

Lets take X = weight of debt

( 1 -x) = weight of equity

Cost of debt after tax = cost of debt pretax( 1- t)

Kd = 10 (1- .036)

Kd = 6.4

Ke = 15

WACC = Wd*kd + We*ke

9 = x(6.4) + ( 1-x )15

15 - 9/ 8.6 = x

X = .70

Weight of debt = 69.77%

Weight of equity = 30.23% ( 1-0.6977)

Company debt to equity ratio = Debt / Equity

Debt to equity ratio = 69.77 / 30.23

**Debt to equity ratio = 2.31**

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