The Color Spectrum uses a combination of common stock and debt financing. It als

Question

The Color Spectrum uses a combination of common stock and debt financing. It also wants to structure the firm in a manner that will produce a weighted average cost of capital of 8 percent. The pretax cost of debt is 6.7 percent and the cost of common stock is 10.4 percent. What percentage of the firm's capital funding should be debt financing if its tax rate is 30 percent? (Hint: Find the weight of debt in the formula for WACC. Remember that sum of weights of debt and equity must equal 1.)

a. 38.6%

b. 38.8%

c. 39.2%

d. 39.3%

e. 39.8%

please provide detailed steps. Thanks

Explanation / Answer

LET WEIGHT OF DEBT BE WD

THEREFORE , WEIGHT OF EQUITY = WE = (1-WD)

WACC = WD*KD + WE*KE

8 = WD*(6.7*0.7) + (1-WD)*10.4

8 = 4.69WD + 10.4

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