Fama's Llamas has a weighted average cost of capital of 12 percent

Answer; Option 0.8251

Explanation;

Step 1

Weighted Avarage Cost of Capital = (Weight of Equity x Cost of Equity) + (Weight of Debt x After tax cost of Debt)

here,

Cost of Equity = 17%

After cost of Debt = Cost of Debt ( 1 - Tax) i.e. 9% ( 1 - 34%) = 5.94%

Weight of Equity = W1

Weight of Debt = 100% - W1

Weighted Avarage Cost of Capital = 12%

so,

0.12= (W1 x .017 ) + [ 0.0594 ( 1 - W1)]

0.12= 0.17W1 + 0.0594 - 0.0594W1

0.12 - 0.0594= 0.17W1 - 0.0594W1

0.1106 W1 = 0.0606

W1 = 0.0606 / 0.1106

W1 = 0.5479 or 54.79 %

Weight of Debt = 1 - 0.5479 = 0.4521 or 45.21%

Step 2

Debt Equity ratio = Debt / Equity

here,

Debt = 45.21% ( step 1)

Equity = 54.79% ( step 1)

so,

Debt equity Ratio = 45.21% / 54.79% = 0.8251

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