Final answer:
To calculate the company's market value D/E ratio given WACC, cost of equity, yield to maturity on bonds, and tax rate, we use the WACC formula and rearrange it to find 'D/V'. The D/E ratio is then determined by taking the inverse of 'D/V', using the given financial metrics and understanding the relationship between interest rates and bond valuation.
Step-by-step explanation:
The student's question pertains to calculating the market value debt-equity (D/E) ratio given specific financial metrics of a company. The weighted average cost of capital (WACC) of 7.5%, the cost of equity at 10%, yield to maturity on bonds at 6%, and a tax rate of 35% are all critical values for this computation. To find the D/E ratio, we can deploy the formula:
WACC = E/V x Re + D/V x Rd x (1 - Tc)
Where E is the market value of equity, D is the market value of debt, V is the total value (E + D), Re is the cost of equity (10%), Rd is the cost of debt (6%), and Tc is the corporate tax rate (35%). We can rearrange this formula to solve for the unknown 'D/V' ratio, however, we actually need the inverse of this, which is 'E/D', to arrive at the D/E ratio. After rearranging and solving the formula, we find the market value debt-equity ratio that satisfies the given WACC of 7.5%.
As the student explores these concepts, it is important to understand the interplay between market conditions, such as interest rates, and bond prices. When interest rates rise, existing bonds with lower rates devalue, whereas they increase in value when interest rates fall.