Blue Ribbon, Inc. wants to have a weighted average cost of capital of 10 percent. The ﬁrm has an after-tax cost of debt of 4 percent and a cost of equity of 12 percent. What debt-equity ratio is
Needed for the ﬁrm to achieve their targeted weighted average cost of capital?

Question

Quizplus · Accepted Answer

The correct debt-equity ratio is .33. This can be calculated using the following formula:WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc)where:WACC = weighted average cost of capitalE = market value of equityV = market value of the firmRe = cost of equityD = market value of debtRd = cost of debtTc = corporate tax rateIn this case, we have:WACC = 10%Re = 12%Rd = 4%Tc = 0Substituting these values into the formula, we get:10% = (E/V) * 12% + (D/V) * 4% * (1 - 0)10% = (E/V) * 12% + (D/V) * 4%10% = (E/V) * 12% + (D/V) * 4%10% = (E/V) * 12% + (D/V) * 4%10% = (E/V) * 12% + (D/V) * 4%Solving for D/V, we get:D/V = (10% - (E/V) * 12%) / 4%D/V = (10% - 12%) / 4%D/V = -2% / 4%D/V = -0.5Since the debt-equity ratio cannot be negative, we take the absolute value of -0.5 to get 0.5. Therefore, the debt-equity ratio is 0.5, or 50%.