Question

The school of business tells you the WACC for Realty Assist Inc. is 14%, with the before-tax cost of debt of 10.77%. The school also tells you the required return on equity is 18%. You've found that the tax rate is 21%, then what proportion of a firm is equity financed

Answer 1

The portion of equity finance is 57.86%

Step-by-step explanation:

WACC or weighted average cost of capital is made up of debt and equity capital added in their specific weightage and their cost.

The formula to calculate WACC is,

WACC = D / A * (1-tax) * rD + E /A * rE

Where,

• D / A is debt over total assets
• rD * (1-tax) is the after tax cost of debt
• E / A is Equity over total assets
• rE is the cost of equity

Let x be the portion of equity financing.

Then portion of debt financing is 1 - x as debt + equity = 1.

0.14 = 1-x / 1 * (1 - 0.21) * 0.1077 + x / 1 * 0.18

0.14 = 0.085083 - 0.085083x + 0.18x

0.14 - 0.085083 = 0.094917x

0.054917 / 0.094917 = x

x = 0.57857 or 57.857%