Bigelow SpA has a cost of equity of 13.56% and a pre-tax cost of debt of 7%.The required return on the assets is 11%.What is the firm's debt-equity ratio based on MM Proposition II with no taxes?

Question

Quizplus · Accepted Answer

MM Proposition II with no taxes states that the cost of equity is equal to the required return on assets plus the debt-equity ratio times the difference between the pre-tax cost of debt and the cost of equity (Ke = Ks + (Ks - Kd) x (D/E)).

Therefore, rearranging the formula:

D/E = (Ks - Ke)/(Ks - Kd) 
D/E = (0.1156 - 0.13.56)/(0.1156 - 0.07) 
D/E = 0.64

Thus, the answer is B, with a debt-equity ratio of 0.64.

Bigelow SpA Has a Cost of Equity of 13