Question

A firm has a WACC of 14%, an expected return on equity of 19%, and a debt-to-asset ratio of 60%. If the firm does not pay tax, what is the interest rate on the debt?

A. 6.50%
B. 9.90%
C. 10.67%
D. 11.14%

Answer 1

To find the interest rate on the debt, we can use the formula for the weighted average cost of capital (WACC). Given that the firm has a WACC of 14% and a debt-to-asset ratio of 60%, the interest rate on the debt is approximately 10.7%. The correct answer is C. 10.67%.

Step-by-step explanation:

To find the interest rate on the debt, we can use the formula for the weighted average cost of capital (WACC):

WACC = (E/V) * Re + (D/V) * Rd

Where:

• E = value of equity
• V = total value of the firm (E + D)
• Re = expected return on equity
• D = value of debt
• Rd = interest rate on debt

Given that the firm has a WACC of 14% and a debt-to-asset ratio of 60%, we can set up the equation:

0.14 = (0.4 * 0.19) + (0.6 * Rd)

Simplifying this equation, we get:

0.14 = 0.076 + 0.6Rd

0.064 = 0.6Rd

Rd = 0.064 / 0.6

Rd ≈ 0.107 or 10.7%

So, the interest rate on the debt is approximately 10.7%.

The correct answer is C. 10.67%.