An all-equity firm has a cost of capital of 12.8 percent and a tax rate of 23 percent. At the firm's target debt-equity ratio, the pretax cost of debt is 7.35 percent and the cost of equity is 15.07 percent. What is the target debt-equity ratio

target debt-equity ratio = 63.11 %

Explanation:

given data

cost of capital Keu = 12.8 percent

tax rate T = 23 percent

pretax cost of debt Kd = 7.35 percent

cost of equity Ke = 15.07 percent

solution

we get here target debt-equity ratio that is express by levered cost of equity

levered cost of equity = cost of capital  + ( cost of capital  - pretax cost of debt ) ×  × (1  - tax rate )   ..............................1

put here value and we get

15.07 % = 12.8 % + (12.8 % - 7.35 %)  ×  × (1 - 34 %)

15.07 % = 12.8% + 0.03597 ×

= (15.07% - 12.8%) ÷ 0.03597

= 0.6311

target debt-equity ratio = 63.11 %

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