Question

Black and White has a cost of equity of 11 percent and a pre-tax cost of debt of 8.5 percent. The firm’s target weighted average cost of capital is 9 percent and its tax rate is 40 percent. What is the firm’s target debt-equity ratio?

A. 48.29

B. 51.28

C. 55.72

D. 57.56

E. 62.03

________

Suppose the returns on common stocks are approximately normally distributed. If the average return is 17% and a standard deviation of 12% what range of returns would one expect to see 95% of the time?

A. 5% to 29%

B. -7% to 41%

C. -19% to 53%

D. -19% to 53%

E. -27% to 53%

Answer 1

1)	Let the weight of equity be w. The weight of debt would
	then be 1-w.
	Now
	9 = 11*w+8.5*0.60*(1-w)
	Solving for w
	9 = 11*w+5.1*(1-w)
	9 = 11*w+5.1-5.1*w
	9-5.1 = 5.9*w
	w = 3.9/5.9 = 0.6610
	D/E = 0.3390/0.6610 = 51.29
	Answer: Option: [B] 51.28
2)	It would lie between Avg.Return +/-3*SD
	That is, between
	= 17%+3*12% = 53%
	=17%-3*12% = -19%
	Answer: Option: [C] -19% to 53%
	Note: Option [D] also gives the same answer