Calculate the debt-to-total-market-value ratio that would result in ABC having a weighted average cost of capital of 7.5%.
A)28%
B)38%
C)46%
D)50%

Question

Quizplus · Accepted Answer

The debt-to-total-market-value ratio can be calculated as follows:
weighted average cost of capital = cost of equity x % of equity + cost of debt x % of debt x (1 - tax rate)
7.5% = cost of equity x (1 - debt-to-total-market-value ratio) + cost of debt x debt-to-total-market-value ratio x (1 - tax rate)
We can assume a tax rate of 35%, cost of equity of 10%, and cost of debt of 5%. 
7.5% = 10%(1 - debt-to-total-market-value ratio) + 5% x debt-to-total-market-value ratio x (1- 35%)
Solving for debt-to-total-market-value ratio gives us 38%. Therefore, the answer is B.

Calculate the Debt-To-Total-Market-Value Ratio That Would Result in ABC Having