Question

The Outlet Mall has a cost of equity of 13.9 percent, a pretax cost of debt of 71 percent, and a return on assets of 12 percent. Ignore taxes. What is the debt-equity ratio? Multiple Choice 2.58 a .39 o 2.23 .45 48

Answer 1

Given,

Cost of equity = 13.9% or 0.139

Cost of debt = 7.1% or 0.071

Return on assets = 12% or 0.12

Solution :-

Let weight of equity be 'w'

weight of debt be '1-w'

Now,

return on assets = (cost of equity)(weight of equity) + (cost of debt)(weight of debt)

0.12 = (0.139)(w) + (0.071)(1 - w)

0.12 = (0.139)(w) + 0.071 - (0.071)(w)

0.12 - 0.071 = (0.139)(w) - (0.071)(w)

0.049 = (0.068)(w)

0.049/0.068 = w

0.720588235 = w

weight of debt = 1 - 0.720588235 = 0.279411765

Debt-equity ratio = weight of debt/weight of equity

= 0.279411765/0.720588235 = 0.39