A Firm Has an Expected Return on Equity of 16

question 32

Multiple Choice

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%?

• A).50
• B).75
• C)1.00
• D)1.50 Let x = debt/asset ratio.Then
• )12 = .08x + (1-x).16
• = )08x + .16 - .16x
• )08x/.08 = .04/.08
• X = .50

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Definitions:

Balance Sheet Columns

The sections of a balance sheet which typically include assets, liabilities, and shareholders' equity.

Drawing Account

An account used to record withdrawals made by a business owner or partner from the company for personal use.

Balance Sheet Debit

An entry on the left side of a balance sheet, typically indicating an increase in assets or a decrease in liabilities or equity.

Net Income

Profits after subtracting all costs, including operating expenses, interest, and taxes, from total revenue, indicating the final earning outcome of a business.