First question: What is the proportion of debt financing for a firm that expects a 24% return on equity, a 16% return on assets, and a 12% return on debt? Ignore taxes.
I understand that the answer is 66.7%
I am using the WACC formula WACC = E/V * Re + D/V *Rd * (1-Tc) Where Re = Cost of equity; Rd = cost of debt; E= market value of the firm's equity; D = Market value of debt; V = (E + D); E/V percentage of financing that is equity
D/V percentage of financing that is debt
Tc= corporate Tax rate
I only come up with three values : 16.0 ; 6% and 9%. I understand that I add these three. As you can see it adds up to 31%
The following is simmilar situation.
Follow up question:A firm has an expected return on equity of 16% and an after-tax cost of debt of 8%. What debt-equity ratio should be used in order to keep the WACC at 12%?
I understand that the answer is 1
I am a visual lerner so I need to see and understand how the formula works and the pieces ralate to each other.
If there is a simpler formula, I'd love that as well.
The formula for WACC is
WACC = Proportion of debt X cost of debt + Proportion of equity x cost of equity
And Proportion of debt + Proportion of equity = 1
Since we have to find the porportion of debt, we will use (1-proportion of debt) for ...
The solution explains how to calculate the proportion of debt financing and debt to equity ratio given the WACC