Bigelow has a levered cost of equity of 14.29 percent and a pretax cost of debt of 7.23 percent.The required return on the assets is 11 percent.What is the firm's debt-equity ratio based on MM Proposition II with no taxes?
A).67
B).87
C).72
D).75
E).81

Question

Quizplus · Accepted Answer

MM Proposition II without taxes states that the cost of equity (Re) is equal to the cost of assets (Ra) plus the debt-equity ratio (D/E) times the spread between the cost of assets and the cost of debt (Rd). The formula is Re = Ra + (D/E)(Ra - Rd). Rearranging the formula to solve for D/E gives us D/E = (Re - Ra) / (Ra - Rd). Plugging in the given values: (14.29% - 11%) / (11% - 7.23%) = 3.29 / 3.77 = 0.872. Therefore, the firm's debt-equity ratio is approximately 0.87 or 87%.

Bigelow Has a Levered Cost of Equity of 14