Mountain Groves has an unlevered cost of capital of 13.2 percent, a cost of debt of 8.3 percent, and a tax rate of 21 percent. What is the target debt-equity ratio if the targeted cost of equity is 14.5 percent?

Answer: D/E ≥ 0.3358

Explanation:

Given that,

Unlevered cost of capital = 13.2 %

Cost of debt = 8.3 %

Tax rate = 21 %

Targeted cost of equity = 14.5 %

D/E = target debt-equity ratio

Targeted cost of equity ≥ Unlevered cost of capital + (Unlevered cost of capital - Cost of debt) * D/E * (1 - Tax rate)

14.5% ≥ 13.2% + (13.2% - 8.3%) * D/E * (1 - 21%)

0.013 ≥ 0.03871 * D/E

D/E ≥ 0.3358

Therefore, the target debt-equity ratio is D/E ≥ 0.3358.