Acetate Inc has common stock with a market value of $20 million and
debt with a market value of $10 million.  The cost of debt is 14
percent.  The current Treasury-bill rate is 8 percent and the expected
market premium is 10 percent.  The beta on Acetate's equity is 0.9.
a) What is Acetate's debt-equity ratio?
b) What is the firm's overall required return?

Hi again lola5!!

First of all define the variables:

E = value of equity
D = value of debt = 
rE = cost of equity
rD = cost of debt
rF = risk free rate = Treasury-bill rate
rP = market risk premium = rE - rF 
rW = overall required return (WACC)


a) What is Acetate's debt-equity ratio?

The company's debt-equity ratio indicates the proportion of equity and
debt that the company is using to finance its assets:
 
Acetate's Debt-Equity Ratio = Total debts / Total equities =
                            = $10 million / $20 million =
                            = 0.5

See "Debt/Equity Ratio":
http://www.investopedia.com/terms/d/debtequityratio.asp

                           ------------------------

b) What is the firm's overall required return?

According to the CAPM to find rE (cost of equity) we have that:

rE = rF + rP * BETA =
   = 0.08 + 0.10 * 0.9 = 
   = 0.17

See "CAPM - Capital Asset Pricing Model":
http://www.valuebasedmanagement.net/methods_capm.html


The overall required return is the weighted average cost of capital;
since in this case no taxes are set we have that:

rW = rE * E/(E+D) + rD * D/(E+D) =
   = 0.17 * 20/30 + 0.14 * 10/30 =
   = 0.16

The firm's overall required return is 16%.

See "Weighted Average Cost of Capital - WACC".
http://www.investopedia.com/terms/w/wacc.asp


----------------------------------------------------------

I hope that this helps you. Feel free to request for a clarification
if you need it.

Best regards.
livioflores-ga

Hi Lola
Here are answers to your question.
1)the debt-equity ratio=debt/common stock=10m/20m=0.5
2)the required return for firm=risk free rate + firm equity beta *
market premium=8+0.9*10=17 percent

I hope them help to your question.If further question, let me know.

Good luck.
Sarah