Fama’s Llamas has a weighted average cost of capital of 9.8 percent. The company’s cost of equity is 13 percent, and its pretax cost of debt is 7.5 percent. The tax rate is 21 percent. What is the company’s target debt-equity ratio? (Do not round intermediate calculations and round your answer to 4 decimal places, e. g., .1616.)

46:54

Explanation:

Given that,

Weighted average cost of capital = 9.8 percent

Cost of equity = 13 percent

Pretax cost of debt = 7.5 percent

Tax rate = 21 percent

The target debt-equity ratio refers to the ratio of debt to equity.

The formula for Weighted average cost of capital is as follows:

WACC = [weight of debt × Cost of Debt (1 - tax rate)] + (weight of equity × cost of equity)

Let the weight of debt be x, then the weight of equity is (1 - x),

0.098 = [x × 0.075 (1 - 0.21)] + ((1 - x) × 0.13)

0.098 = 0.06x + 0.13 - 0.13x

0.098 = 0.13 - 0.07x

0.07x = 0.13 - 0.098

0.07x = 0.032

Weight of debt: x = 0.46 or 46%  

Weight of equity: (1 - x) = (1 - 0.46)

                                      = 0.54 or 54%

Therefore, the company’s target debt-equity ratio is 46:54.

by knowing conditionality

explanation: