Question

The firm's market value debt/equity ratio is 25%, its cost of equity is 14%, and its pretax cost of debt is 7%. What does a debt/equity ratio of 25% mean. How do I calculate my debt from the ratio

Answer 1

the question indicates that for every 4 dollars of equity you have a debt of 1 dollar.

this implies( in absence of tax shield) :

costofcapital={(25/(25+100))∗.07+(100/125)*.14}


in case of tax shield i.e; if the interest on debt is exempted from tax payment. Supposing a tax rate of 40%

costofcapital=(debt/capital)∗(1−Tax)∗costofdebt+(Equity/Capital)∗costofequity

costofcapital=(25/125)∗(1-.4)*.07+(100/125)*.14

Answer 2

Thanks so much Sailu. Take care