Question

Sparky Inc. has a WACC of 9.078%. The company’s equity beta is 1.3 and its semi-annual coupon bonds have a yield-to-maturity of 7.2% (APR, semi-annually compounded). The risk-free rate is 3.0%, the expected return on the market portfolio is 10.0%, and the tax rate is 35%.

What Sparky's debt-to-equity (D/E) ratio?

Select one:

0.41

0.70

0.62

0.59

1.73

1.00

0.50

Insufficient information, too many unknown variables.

Answer 1

Cost of Equity = Risk free rate + Beta *(Market return-Risk Free rate)
		3.0% + 1.3 (10% - 3%) = 12.10%
After tax cost of debt = YTM (1-t)
		7.20% (1-0.35 ) = 4.68%
Let
Weights of debt = x
weightts of equity = 1-x
WACC = 4.68x + (1-x)*12.10
9.078 = 4.68x + 12.10-12.10x
7.42x = 3.022
x= 0.41
Debt weight = 0.41
Equity weight = 1-0.41 = 0.59
Debt equity rati o= Debt/ Equity
		0.41 / 0.59 =0.695
Answer is 0.70