Question

Company Y has WACC of 11 %. The cost of equity capital is 14% and pretax cost of debt is 2%. Company tax rate is 35%.

Calculate the equity to firm value ratio (E/V).

Calculate the debt to equity ratio (D/E).

I leave A like !

Answer 1

Solution:-

First we need to calculate Weight-

Let Weight of Equity = X

Weight of Debt = 1-X

After tax cost of Debt = 2% (1-0.35)

After tax cost of Debt = 1.30%

WACC = Weight of Debt * Cost of Debt after Tax + Weight of Equity * Cost of Equity

0.11 = (1-X) * 0.013 + X * 0.14

0.11 = 0.013 - 0.013X + 0.14X

0.11 - 0.013 = 0.127X

0.097 = 0.127X

X =

X = 0.764

Weight of Equity = 0.764

Weight of Debt = 1 - 0.764 = 0.236

To Calculate Equity to Firm Value Ratio-

Equity to Firm Value Ratio =

Equity to Firm Value Ratio =

Equity to Firm Value Ratio = 0.764

To Calculate Debt to Equity Ratio-

Debt to Equity Ratio =

Debt to Equity Ratio =

Debt to Equity Ratio = 0.3089

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