Question

Munkins Inc. has a WACC of 15%. The company’s cost to equity is 18% and cost to debt is 8%. What is the company’s debt/equity ratio if its marginal tax rate is 35%?

Select one:

a. 23.44%

b. 50.00%

c. 30.62%

d. 76.56%

Answer 1

Correct Answer is c)30.62%

WACC = (Weight of Equity x Cost of Equity) + Weight of Debt x Cost of Debt (1- tax rate)

Let assume Y be the Weight of Equity, then weight of debt =(1-Y)

We are given with following details

Cost of Equity =18%

Cost of Debt = 8%

Tax rate = 35%

WACC =15%

Substituting values in equation we get

WACC = (Weight of Equity x Cost of Equity) + Weight of Debt x Cost of Debt (1- tax rate)

0.15 = 0.18Y + (1-Y) x 0.08(1-.0.35)

0.15 = 0.18Y +0.052-0.052Y

0.098 =0.128Y

Y =0.098/0.128

Y=0.7656

there fore weight of equity =76.56%

Weight of Debt =( 1- weight of Equity) = (1-0.7656) =23.44%

Debt Equity Ratio = Debt / Equity

=23.44/ 76.56

Debt Equity Ratio =30.62%