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

The proportion of equity financing can be calculated using the WACC formula:

WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc)

Where E is the market value of equity, V is the total market value of the firm, Re is the required rate of return on equity, D is the market value of debt, Rd is the after-tax cost of debt, and Tc is the corporate tax rate.

We are given WACC = 14%, Rd = 7.0%, and Tc = 35%. Let x be the proportion of equity financing, then the proportion of debt financing is (1 - x). Therefore, we have:

14% = x * 18% + (1 - x) * 7.0% * (1 - 0.35)

14% = 0.18x + 0.0315 - 0.021x
0.021x = 0.14 - 0.0315
x = 0.6359 = 63.59%

Therefore, the proportion of equity financing is approximately 63.59%, which is closest to choice B) 63.64%.

What Proportion of a Firm Is Equity Financed If the WACC