What is the maximum rate that can be paid on debt and maintain a 14% WACC with a 19% expected return on equity in a firm with a 60% debt-to-asset ratio? Ignore taxes.
A) 6.50%
B) 9.90%
C) 10.67%
D) 11.14%

Question

Quizplus · Accepted Answer

WACC formula: WACC = (E/V x Re) + (D/V x Rd) x (1 - T)

Given, 
Debt-to-asset ratio (D/A) = 60%
Equity-to-asset ratio (E/A) = 40%
Expected return on equity (Re) = 19%
WACC = 14%

We need to find the maximum rate that can be paid on debt (Rd).

Putting the given values in the WACC formula, we get:

14% = (0.4 x 19%) + (0.6 x Rd)
14% = 7.6% + 0.6Rd
0.6Rd = 14% - 7.6%
0.6Rd = 6.4%
Rd = 6.4% / 0.6
Rd = 10.67%

Therefore, the maximum rate that can be paid on debt and maintain a 14% WACC with a 19% expected return on equity in a firm with a 60% debt-to-asset ratio is 10.67%.

Hence, the answer is (C).

What Is the Maximum Rate That Can Be Paid on Debt