7 You did not receive full credit for this question in a pre

7. You did not receive full credit for this question in a previous attempt Fama\'s Llamas has a weighted average cost of capital of 9.9 percent. The company\'s cost of equity is 13 percent, and its cost of debt is 7.9 percent. The tax rate is 40 percent. What is the company\'s debt-equity ratio? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.) Debt-equity ratio

Solution

Debt -Equity ratio is         0.6008 Workings: After Tax cost of debt = Before Tax cost of debt*(1-Tax rate) = 7.9%*(1-0.40) = 4.74% Weighted Average cost of Capital = (Weight of debt*After tax cost of debt)+(Weight of Equity*Cost of Equity) Now, Suppose weight of debt is \"x\" and so weight of equity would be \"1-x\" As per Question, Weighted Average cost of Capital = (Weight of debt*After tax cost of debt)+(Weight of Equity*Cost of Equity) or,            0.099 = (x*0.0474)+(*1-x)*0.13) or,            0.099 = 0.0474x+0.13-0.13x or,            0.099 = -0.0826x+0.13 or,            -0.03 = -0.0826x or, x =           0.38 so, 1-x = 1 -           0.38 =           0.62 So, Debt              0.38 4.74% Equity              0.62 13% and Debt-Equity ratio = Debt/Equity =           0.38 /           0.62 =      0.6008