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Question:

The following data applies to LeVeit Company:

LeVeit has a target debt-to-equity ratio of 0.5.

LeVeit’s bonds are currently yielding 10%.

LeVeit is a constant growth (5%) firm that just paid a dividend of $3.00.

•LeVeit’s stock sells for $31.50 per share.

• The company’s marginal tax rate is 40%.

The company’s weighted after-tax cost of capital is closest to:

A
12.0%.

Explaination

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If the company has a debt-to-equity ratio of 0.5, it will have $0.50 in debt for each $1.00 in equity. V = debt + equity = 0.5 + 1 = 1.5. Therefore, the weight is 33.3% (0.5 / 1-5) for the debt component and 66.7% (1.0 / 1.5) for the equity component.

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