Question

AP Products has a pretax cost of debt of 6.4 percent and an unlevered cost of capital of 12.6 percent. The firm's tax rate is 35 percent and the cost of equity is 16.8 percent. What is the firm's debt-equity ratio? OA) 1.61 OB) 1.04 OC) 1.23 OD) 1.39 OE) 1.07

Answer 1

Weighted average cost of capital (WACC)= (k_{​​​​​d}*w_​​​1)+(K_{​​​​​​e*}w_​2)

Where

kd = cost of Debt

ke = cost of equity

W1 = weight of debt = 6.4%*(1-0.35) = 4.16%

W2 = weight of stock

W1+W2 = 1

1-W1 = W2......(1)

WACC =  (k_{​​​​​d}*w_​​​1)+(K_{​​​​​​e*}w_​2)

12.6 = (4.16*w1)+ (16.8*w2)

12.6 = 4.16w1+ 16.8*(1-W1)....... according to (1)

12.6 = 4.16w1+ 16.8- 16.8w1

12.64 w1 = 4.8

W1 = 0.38

W2 = . 62

Debt equity ratio = DEBT/ EQUITY

= 0.62/0.38

= 1.62

The option A) 1.61 is a correct answer

I hope my efforts will be fruitful to you ..?