Question

Kountry kitchen has a cost of equity of 11.8 percent, a pretax cost of debt of 6.4 percent, and the tax rate is 24 percent. if the company's WACC is 8.95 percent, what is its debt-equity ratio?

O 1.67
O .83
O .70
O 1.43
O .41

Answer 1

To find the debt-equity ratio, we use the WACC formula. After rearranging the formula and solving for D/V (D/E ratio), we determine that the debt-equity ratio is approximately 0.70, indicating the company has $0.70 of debt for every $1 of equity.

option c is the correct

Step-by-step explanation:

The student is asking about calculating the debt-equity ratio using the Weighted Average Cost of Capital (WACC). The formula for WACC is WACC = E/V * Re + D/V * Rd * (1-Tc), where E is the market value of the equity, V is the total market value of equity and debt, Re is the cost of equity, D is the market value of debt, Rd is the cost of debt, and Tc is the corporate tax rate.

Given:
Cost of Equity (Re) = 11.8%
Pretax Cost of Debt (Rd) = 6.4%
Tax Rate (Tc) = 24%
WACC = 8.95%

Using the information provided and the WACC formula, we can set up the equation:
0.0895 = (E/V) * 0.118 + (D/V) * 0.064 * (1-0.24)

The equation simplifies to:
0.0895 = 0.118 * (E/V) + 0.04864 * (D/V)

We can express E/V as 1-D/V because the total value of the firm V is the sum of debt D and equity E (V = D + E), hence E/V is 1 - D/V. Now we substitute E/V in our equation:
0.0895 = 0.118 * (1 - D/V) + 0.04864 * (D/V)

Solving for D/V, we find the debt-equity ratio which is D/E, and after solving the equation, we find that the ratio is approximately 0.70. This tells us that for every dollar of equity, the company has $0.70 of debt.