Answer:
Option 4
Explanation:
In this question ,we have to compute the WACC which is shown below:
= Weightage of debt × cost of debt × ( 1- tax rate) + (Weightage of common stock) × (cost of common stock)
For Option 1, it would be
= (0.3 × 10%) × ( 1 - 40%) + (0.7 × 12.5%)
= 1.8% + 8.75%
= 10.55%
For Option 2, it would be
= (0.4 × 10.5%) × ( 1 - 40%) + (0.6 × 13%)
= 2.52% + 7.8%
= 10.32%
For Option 3, it would be
= (0.5 × 11%) × ( 1 - 40%) + (0.5 × 13.5%)
= 3.3% + 6.75%
= 10.05%
For Option 4, it would be
= (0.6 × 11.7%) × ( 1 - 40%) + (0.4 × 14.2%)
= 4.212% + 5.68%
= 9.89%
For Option 5, it would be
= (0.7 × 13%) × ( 1 - 40%) + (0.3 × 15.5%)
= 5.46% + 4.65%
= 10.11%
So based on this, the management should accept option 4 as it derives the best debt asset ratio
The weightage of equity would be come
= 1 - weightage of debt
