Glover Tools has a pre-tax cost of debt of 9% and an unlevered cost of capital of 13.5%. The firm's tax rate is 34% and the cost of equity is 15%. What is the firm's debt-equity ratio?
A) .42
B) .48
C) .51
D) .58
E) .64

Question

Quizplus · Accepted Answer

The firm's debt-equity ratio can be calculated using the formula for the weighted average cost of capital (WACC) and the Modigliani-Miller Proposition II with taxes. The WACC is a weighted average of the cost of equity and the after-tax cost of debt. By setting the WACC equal to the unlevered cost of capital and solving for the debt-equity ratio, we find that it is approximately 0.51.

Glover Tools Has a Pre-Tax Cost of Debt of 9