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What debt-equity ratio is needed for the firm to achieve their targeted weighted average cost of capital?
Phil's Carvings, Inc. wants to have a weighted average cost of capital of 8 percent. The firm has an aftertax cost of debt of 5 percent and a cost of equity of 10 percent. What debt-equity ratio is needed for the firm to achieve their targeted weighted average cost of capital?
.67
.50
.57
.77
.84
2 Answers
- 1 decade agoFavorite Answer
WACC = (E/V)*Re + (D/V)*Rd*(1-Tc)
0.08 = (E/V)*0.1 + (D/V)*0.05
{0.08 = (E/V)*0.1 + (D/V)*0.05}*(V/E)
0.08(V/E) = 0.1 + 0.05(D/E)
where, V/E = 1 + D/E
Then, 0.08(D/E+1) = 0.1 + 0.05(D/E)
0.08(D/E) + 0.08 = 0.1 + 0.05(D/E)
0.03(D/E) = 0.02
(D/E) = 0.666666666.....
Thus, 0.67
Source(s): WACC = (E/V)*Re + (D/V)*Rd*(1-Tc)