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A firm wants to create a WACC of 11.2 percent. The firm's cost of equity is 16.8 percent and its pretax cost of debt is 8.7 percent. The tax rate is 35 percent. What does the debt-equity ratio need to be for the firm to achieve its target WACC

Respuesta :

Answer:

The debt-equity ratio need to be 1.01 for the firm to achieve its target WACC

Explanation:

In order to calculate the debt-equity ratio we would have to calculate the following formula:

debt-equity ratio=Weight of debt/Weight of equity

To calculate the Weight of debt we would have to use the formula to calculate the WACC as follows:

WACC = Wd×Rd×(1-t)+We×Ke

Therefore, according to the given data:

11.20% = Wd×8.70%×(1-35%)+(1-Wd)×16.80%

11.20% = Wd×5.655%+16.80%-16.80%×Wd

11.145%×Wd = 5.60%

Weight of debt=0.5025

Weight of equity=1-Weight of debt

Weight of equity=1-0.5025

Weight of equity=0.4975

Therefore, debt-equity ratio=0.5025/0.4975

debt-equity ratio=1.01

The debt-equity ratio need to be 1.01 for the firm to achieve its target WACC

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