Bigelow SpA has a cost of equity of 13.56% and a pre-tax cost of debt of 7%.The required return on the assets is 11%. What is the ﬁrm's debt-equity ratio based on MM Proposition II with no taxes?
A).60
B).64
C).72
D).75
E).80

Question

Quizplus · Accepted Answer

MM Proposition II without taxes states that the cost of equity (Re) is equal to the required return on assets (Ra) plus the debt-equity ratio (D/E) times the spread between the required return on assets and the cost of debt (Rd). The formula can be expressed as Re = Ra + (D/E)(Ra - Rd). Rearranging the formula to solve for D/E gives us D/E = (Re - Ra) / (Ra - Rd). Plugging in the given values: D/E = (13.56% - 11%) / (11% - 7%) = 2.56% / 4% = 0.64. Therefore, the firm's debt-equity ratio is 0.64, or 64 when expressed as a percentage.

Bigelow SpA Has a Cost of Equity of 13