A fiRm Has an Unlevered Cost of Capital of 10

question 26

Multiple Choice

A firm has an unlevered cost of capital of 10%, a cost of debt of 9%, and a tax rate of 34%. If it desires a cost of equity of 14%, what is its target debt/equity ratio?

• A) 2.49
• B) 3.89
• C) 4.68
• D) 5.14
• E) 6.06

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Definitions:

Secure Neighborhood

An area with low crime rates and effective safety measures, making it a desirable place to live.

Adverse Selection

Adverse selection is a situation in economics where one party in a transaction has more information than the other, often leading to an imbalance and unfavorable outcomes for one side.

Screening

A solution to the problem of adverse selection that describes the efforts of a less informed party to gather information about the more informed party. A successful screen means that it is unprofitable for bad types to mimic the behavior of good types. Any successful screen can also be used as a signal.

Signaling

A solution to the problem of adverse selection that describes an informed party’s effort to communicate her type, risk, or value to less informed parties by her actions. A successful signal is one that bad types won’t mimic. Any successful signal can also be used as a screen.