Your firm has a pre-tax cost of debt of 8% and an unlevered cost of capital of 13%.Your tax rate is 35% and your cost of equity is 15.26%.What is your debt-equity ratio?
A).61
B).66
C).70
D).74
E).78

Question

Quizplus · Accepted Answer

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

Debt-Equity Ratio = Debt / Equity

We know that the weighted average cost of capital (WACC) is given by:

WACC = (Cost of Equity * Equity / Total Capital) + (Cost of Debt * (1 - Tax Rate) * Debt / Total Capital)

We can rearrange this formula to solve for the debt-equity ratio:

Debt-Equity Ratio = (WACC - Cost of Equity) / (Cost of Debt * (1 - Tax Rate) - WACC + Cost of Equity)

Substituting the given values, we get:

Debt-Equity Ratio = (0.13 - 0.1526) / (0.08 * (1 - 0.35) - 0.13 + 0.1526) = 0.70

Therefore, the correct answer is  C) 0.70.

Your Firm Has a Pre-Tax Cost of Debt of 8