Here is the problem:Famas's LLamas has a weighted average cost of capital of  7.9%. The company's cost of equity is 11% and its pretaxt cost of debt is 5.8%. The taxt rate is 25%. What is the company's target debt-equity ratio?Here is the solution:Here we have the WACC and need to find the debt-equity ratio of the company. Setting up the WACC equation, we find:        WACC = .0790 = .11(E/V) + .058(D/V)(1 – .25)        Rearranging the equation, we find:        .0790(V/E) = .11 + .058(.75)(D/E)        Now we must realize that the V/E is just the equity multiplier, which is equal to:        V/E = 1 + D/E        .0790(D/E + 1) = .11 + .0435(D/E)           Now we can solve for D/E as:        .0355(D/E) = .031              D/E = .8732 Question:I need help especifically with the part where they rearrange the equation as:.0790(V/E) = .11 + .058(.75)(D/E).How do they get an inverse (V/E) on the left side without the .11. And how do they get a (D/E) ratio.I understand the rest of the problem. Thanks

Question
Asked May 12, 2019
59 views

Here is the problem:

Famas's LLamas has a weighted average cost of capital of  7.9%. The company's cost of equity is 11% and its pretaxt cost of debt is 5.8%. The taxt rate is 25%. What is the company's target debt-equity ratio?

Here is the solution:

Here we have the WACC and need to find the debt-equity ratio of the company. Setting up the WACC equation, we find:

 

       WACC = .0790 = .11(E/V) + .058(D/V)(1 – .25)

 

       Rearranging the equation, we find:

 

       .0790(V/E) = .11 + .058(.75)(D/E)

 

       Now we must realize that the V/E is just the equity multiplier, which is equal to:

 

       V/E = 1 + D/E

 

       .0790(D/E + 1) = .11 + .0435(D/E)   

 

       Now we can solve for D/E as:

 

       .0355(D/E) = .031  

            D/E = .8732

 

Question:

I need help especifically with the part where they rearrange the equation as:

.0790(V/E) = .11 + .058(.75)(D/E).

How do they get an inverse (V/E) on the left side without the .11. And how do they get a (D/E) ratio.

I understand the rest of the problem. Thanks

 

check_circle

Expert Answer

Step 1

Calculation of Weight of Debt:

The weight of debt is calculated using the WACC formula, where the weight of debt is assumed as X.

fullscreen
Step 2

Now solve for X,

By solving for X, we get the weight of debt as 0.466165.

fullscreen
Step 3

Calculation of Weight of Equity:

...
fullscreen

Want to see the full answer?

See Solution

Check out a sample Q&A here.

Want to see this answer and more?

Solutions are written by subject experts who are available 24/7. Questions are typically answered within 1 hour.*

See Solution
*Response times may vary by subject and question.
Tagged in

Business

Finance

Related Finance Q&A

Find answers to questions asked by student like you

Show more Q&A add
question_answer

Q: At the age of 33​, to save for​ retirement, you decide to deposit $80 at the end of each month in an...

A: NOTE: There is some information missing in the question. The retirement age in not mentioned in the ...

question_answer

Q: Chang Industries has bonds outstanding with a par value of $200,000 and a carrying value of $203,000...

A: Calculation of gain or loss on retirement:

question_answer

Q: A firm has the following investment  Cash inflows Year                A                       B     ...

A: g. This question asks for Project A's Internal Rate of Return and the decision if the firm's cost of...

question_answer

Q: Micro-Technologies is a Bio Tech research firm that is conducting research on a cure for Aids. Their...

A: Step1: Calculating the value of after-tax cash outflow under lease arrangement. We have,Lease paymen...

question_answer

Q: Capital budgeting problems  and what king of you used for solving (NPV and IRR PROBLEMS ) A firm has...

A: The question has 6 sub parts and we’re entitled to solve only 3 sub parts in one question. So, kindl...

question_answer

Q: Suppose that C is the price of a European call option to purchase a security whose present price is ...

A: As a first step, let's assimilate the information given to us:Current stock price is SC is the price...

question_answer

Q: A firm evaluates all of its projects by applying the IRR rule. The required return for the following...

A: Calculation of IRR:Using Excel Spreadsheet:

question_answer

Q: Find the following values for a lump sum assuming annual compounding: The future value of $500 inve...

A: Before we get into the solution, let's understand two reciprocal concepts:If present value (PV) is k...

question_answer

Q: Grill Works and More has 8 percent preferred stock outstanding that is currently selling for $49 a s...

A: Calculation of Cost of Preferred Stock: