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14 August, 08:02

Bigelow has a levered cost of equity of 14.29 percent and a pretax cost of debt of 7.23 percent. The required return on the assets is 11 percent. What is the firm's debt-equity ratio based on MM Proposition II with no taxes

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  1. 14 August, 09:31
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    Debt : Equity = 0.87

    Explanation:

    Data given in the question

    Leverage cost of equity = 14.29%

    Pretax cost of debt = 7.23%

    Required return on the asset = 11%

    So by considering the above information, the formula to compute the firm debt equity ratio is

    Return on equity = Return on asset + (Return on assets - cost of debt * Debt : Equity

    14.29% = 11% + (11% - 7.23%) * Debt : Equity

    14.29% = 11% + 3.77% * Debt : Equity

    14.29% - 11% = 3.77% * Debt : Equity

    3.29% = 3.77% * Debt : Equity

    So Debt : Equity = 0.87
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