Phil\'s Carvings, Inc. wants to have a weighted average cost of capital of 8.3 p
ID: 2654959 • Letter: P
Question
Phil's Carvings, Inc. wants to have a weighted average cost of capital of 8.3 percent. The firm has an aftertax cost of debt of 6.1 percent and a cost of equity of 12.2 percent. What debt-equity ratio is needed for the firm to achieve their targeted weighted average cost of capital?
1.56
0.56
2.77
1.77
0.89
Phil's Carvings, Inc. wants to have a weighted average cost of capital of 8.3 percent. The firm has an aftertax cost of debt of 6.1 percent and a cost of equity of 12.2 percent. What debt-equity ratio is needed for the firm to achieve their targeted weighted average cost of capital?
1.56
0.56
2.77
1.77
0.89
Explanation / Answer
Suppose the Proportion of Equity is X
Than the Proportion of Debt will be: 1 - X
WACC = (Proportion of Equity x Cost of Equity) + (Proportion of Debt x Cost of Debt)
8.3 = (X x 12.2) + ((1 - X) x 6.1)
8.3 = 12.2X + 6.1 - 6.1X
8.3 - 6.1 = 12.2X - 6.1X
X = 0.36
So, proportion of Equity is 0.36
Proportion of Debt = 0.64
Debt Equity Ratio = 0.64 / 0.36 = 1.77
So, the correct Option is 1.77