Question

Asked May 12, 2019

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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

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.

Step 2

**Now solve for X,**

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

Step 3

**Calculation of Weight of Equity:**

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