What proportion of a firm is equity financed if the WACC is 14%, the after-tax cost of debt is 7.0%, the tax rate is 35%, and the required return on equity is 18%?

Question

Quizplus · Accepted Answer

Using the WACC formula:
WACC = (E/V)*Re + (D/V)*Rd*(1-T)
where:
E = market value of equity
D = market value of debt
V = total value of the firm (E + D)
Re = required return on equity
Rd = before-tax cost of debt
T = tax rate

We can rearrange the formula to solve for the proportion of equity financing (E/V):
E/V = (WACC - Rd*(1-T))/(Re - Rd*(1-T))
Plugging in the given values:
E/V = (0.14 - 0.07*(1-0.35))/(0.18 - 0.07*(1-0.35))
E/V = 0.6364 or 63.64%
Therefore, choice B is the correct answer.

What Proportion of a Firm Is Equity Financed If the WACC