Question

Acetate, Inc. has equity with a market value of $23.6 million and debt with a market value of $7.08 million

The cost of debt is 9 percent per year Treasury bills that mature in one year yield 5 percent per year, and
the expected return on the market portfolio is 12 percent. The beta of Acetate's equity is 1.21. The firm pays
no taxes
a. What is Acetate's debt-equity ratio? (Do not round intermediate calculations and round your final
answer to 2 decimal places (e.g., 32.16).)
b. What is the firm's weighted average cost of capital? (Do not round intermediate calculations. Enter
your answer as a percent rounded to 2 decimal places (e.g., 32.16))
c. What is the cost of capital for an otherwise identical all-equity firm? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

Answer 1

a. The debt-equity ratio of Acetate, Inc. is 0.30. b. The firm's weighted average cost of capital is 10.06%. c. The cost of capital for an all-equity firm is also 10.06%.

Step-by-step explanation:

a. The debt-equity ratio can be calculated by dividing the market value of debt by the market value of equity. In this case, the market value of debt is $7.08 million and the market value of equity is $23.6 million. Therefore, the debt-equity ratio is $7.08 million / $23.6 million = 0.30.

b. The weighted average cost of capital (WACC) is calculated using the formula WACC = (Weight of Equity imes Cost of Equity) + (Weight of Debt imes Cost of Debt). The weight of equity is the market value of equity divided by the sum of the market value of equity and debt, and the weight of debt is the market value of debt divided by the sum of the market value of equity and debt. The cost of equity is calculated using the formula Cost of Equity = Risk-Free Rate + Beta imes (Expected Market Return - Risk-Free Rate). Plugging in the given values, we can calculate the WACC to be 10.06%.

c. For an all-equity firm, there is no debt, so the debt-equity ratio is 0. Therefore, the WACC is equal to the cost of equity, which we calculated to be 10.06% in the previous step.