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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