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Fama's Llamas has a weighted average cost of capital of 11 percent. The company's cost of...

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Finance

Fama's Llamas has a weighted average cost of capital of 11percent. The company's cost of equity is 16 percent, and its pretaxcost of debt is 9 percent. The tax rate is 31 percent. What is thecompany's target debt-equity ratio? (Do not round yourintermediate calculations.)

multiple choices

  • 1.096

  • 0.9916

  • 1.0856

  • 1.0438

  • 2.5

Answer & Explanation Solved by verified expert
4.2 Ratings (797 Votes)

Let the weight of equity be "X" ,so weight of debt = 1-X

Weighted average cost of capital =[After tax cost of debt *weight of debt] +[cost of equity *weight of equity]

           =[9(1-.31)*(1-x) ] +[16*x]

           =[(9*.69)*(1-x)] +16x

           = [6.21* (1-x)] + 16x

           = 6.21 - 6.21x +16x

           = 6.21 + 9.79x

11 = 6.21 + 9.79x

11-6.21 = 9.79x

4.79/9.79 =X

Weight of equity (X)= .48927

Weight of debt = 1-.48927 = .51073

Debt equity ratio = Total debt /Total equity

                        = .51073 /.48927

                          = 1.0438

correct option is "D"-1.0438
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Transcribed Image Text

Fama's Llamas has a weighted average cost of capital of 11percent. The company's cost of equity is 16 percent, and its pretaxcost of debt is 9 percent. The tax rate is 31 percent. What is thecompany's target debt-equity ratio? (Do not round yourintermediate calculations.)multiple choices1.0960.99161.08561.04382.5

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