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Question of the Week - Corporate Finance

AdaptPrepAdaptPrep Des Moines, IA, USAPosts: 211 Sr Associate
edited March 2015 in Level 1 Questions
Ated Technology's debt/equity ratio is 70%, and the company wants to maintain that ratio. When calculating the weighted average cost of capital, the weight given to the cost of equity (w_e) is closest to:

Question of the Week - Corporate Finance 34 votes

50%
5%
nitinCh.Ministry 2 votes
60%
70%
mattycAndrewKokAdaptPrepTitan33rsparksnmaczRandallK27googs1484ThomasWthendry7karamgjEQ_ArbitragegcompolongomvibstmcinernyHugo_PintoAlex1987bvanove12komrad.sAgre 24 votes
70%
23%
rdxVixen71hamiltonsophiamullerYannickTRichie321PapamedupinPahtsan 8 votes

Comments

  • AdaptPrepAdaptPrep Des Moines, IA, USAPosts: 211 Sr Associate
    60%

    One way to calculate this is to adjust the debt weighting formula:

    w_e = E / (D + E) = E/E / (D/E + E/E) = 1 / (0.7 + 1) = 0.59

    Sometimes the easiest way to solve problems like this is to put in fake numbers. If D/E = 0.7, then we could set D = 7 and E = 10. The equity weight would then be 10 / (10 + 7) = 0.59.

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