Green and Red has a cost of equity of 11% and a pre-tax cost of debt of 8.5%. Th

Question

Green and Red has a cost of equity of 11% and a pre-tax cost of debt of 8.5%. The firm's target weighted average cost of capital is 9% and its tax rate is 35%. What is the firm's target debt-equity ratio? Answer a. 62.03% b. 48.29% c. 51.13% d. 55.72% e. 57.55% Green and Red has a cost of equity of 11% and a pre-tax cost of debt of 8.5%. The firm's target weighted average cost of capital is 9% and its tax rate is 35%. What is the firm's target debt-equity ratio? Green and Red has a cost of equity of 11% and a pre-tax cost of debt of 8.5%. The firm's target weighted average cost of capital is 9% and its tax rate is 35%. What is the firm's target debt-equity ratio? 62.03% 48.29% 51.13% 55.72% 57.55% a. 62.03% b. 48.29% c. 51.13% d. 55.72% e. 57.55%

Explanation / Answer

After tax cost of debt = 8.5%*(1-tax rate) = 8.5%*(1-35%) = 5.53%

Let target debt-equity ratio be X

So debt = X*equity

WACC = debt/(debt+equity) * cost of debt + equity/(debt+equity)*cost of equity = X*equity/(X*equity+equity) * 5.53% + equity/(X*equity+equity) * 11%

This is equal to X/(1+X)*5.53% + 1/(1+X)*11% = 9%

Solving, we get X=57.55%

Hope this helped ! Let me know in case of any queries.

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