Sun Sports has an unlevered cost of capital of 14.3 percent,a cost of debt of 8.7 percent,and a tax rate of 35 percent.What is the target debt-equity ratio if the targeted levered cost of equity is 16.34 percent?

Question

Quizplus · Accepted Answer

We can use the following formula to calculate the target debt-equity ratio:

Target debt-equity ratio = [ (Target levered cost of equity - Unlevered cost of capital) / (Cost of debt - Tax rate) ]

Substituting the given values:

Target debt-equity ratio = [ (16.34% - 14.3%) / (8.7% - 35%) ]
Target debt-equity ratio = 0.56

Therefore, the answer is choice B, with a target debt-equity ratio of 0.56.

Sun Sports Has an Unlevered Cost of Capital of 14