Question

Bermuda Cruises issues only common stock and coupon bonds. The firm has a debt-equity ratio of 1.23. The cost of equity is 12.6 percent and the pretax cost of debt is 7.2 percent. What is the capital structure weight of the firm's equity if the firm's tax rate is 21 percent?


Multiple Choice

.5516


.4206


.5202


.4937


.4484

Answer 1

To find the capital structure weight of the firm's equity, we first need to determine the values of equity and debt based on the debt-equity ratio.

1. **Understanding the Debt-Equity Ratio**:
The debt-equity ratio (D/E) is given as 1.23. This means for every dollar of equity, there is $1.23 of debt.

We can express this as:
\[
D = 1.23E
\]
where \( D \) is the debt and \( E \) is the equity.

2. **Total Value of the Firm (V)**:
The total value \( V \) is the sum of debt and equity:
\[
V = D + E = 1.23E + E = 2.23E
\]

3. **Finding Capital Structure Weights**:
The weight of equity \( W_E \) is calculated as:
\[
W_E = \frac{E}{V}
\]
Substituting for \( V \):
\[
W_E = \frac{E}{2.23E} = \frac{1}{2.23} \approx 0.4484
\]

Now, let's check the final calculation:
\[
W_E = \frac{1}{2.23} \approx 0.4484
\]

Thus, the capital structure weight of the firm's equity is approximately **0.4484**.

**Therefore, the correct answer is: .4484**.