Central Systems Inc desires a weighted average cost of capit

Central Systems, Inc. desires a weighted average cost of capital of 8 percent. The firm has an aftertax cost of debt of 4.8 percent and a cost of equity of 15.2 percent. What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capital?

Solution

Let debt be $x

Equity be $y

Total=$(x+y)

WACC=Respective costs*Respective weights

8=(4.8x/(x+y)+(15.2y/(x+y)

8(x+y)=4.8x+15.2y

8x+8y=4.8x+15.2y

x=(15.2-8)y/(8-4.8)

=2.25y

Hence debt-equity ratio=Debt/Equity

=2.25