Question

# Fama's Llamas has a weighted average cost of capital of 12.5 percent. The company's cost of...

Fama's Llamas has a weighted average cost of capital of 12.5 percent. The company's cost of equity is 17 percent, and its pretax cost of debt is 7 percent. The tax rate is 34 percent. What is the company's target debt-equity ratio?

Stock in Country Road Industries has a beta of 0.91. The market risk premium is 7.5 percent, and T-bills are currently yielding 5 percent. The company's most recent dividend was \$1.7 per share, and dividends are expected to grow at a 5 percent annual rate indefinitely. If the stock sells for \$37 per share, what is your best estimate of the company's cost of equity

1) Debt-Equity Ratio is 0.57

 Step-1:Calculation of weight of debt and Equity Weighted Average cost of capital = (Wd*Kd)+(We*Ke) 0.1250 = (x*0.0462)+((1-x)*0.17) 0.1250 = (0.0462x)+(0.17-0.17x) 0.1250 = -0.1238x+0.17 -0.0450 = -0.1238x 0.1238x = 0.0450 x = 0.3635 1-x = 0.6365 Working: Assumed weight of Debt is "x" and Equity is "1-x". After tax cost of debt = Before tax cost of debt * (1-Tax Rate) = 7%*(1-0.34) = 0.0462 Step-2:Calculation of debt-Equity Ratio Debt-Equity Ratio = Weight of debt / Weight of Equity = 0.3635 / 0.6365 = 0.57

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