Question

Q22) Starset, Inc., has a target debt-equity ratio of 0.84. Its WACC is 11 percent, and the tax rate is 32 percent.

A) If the company's cost of equity is 15.5 percent, what is the pretax cost of debt?

• 8.3%
• 14.92%
• 10.62%
• 9.05%
• 7.95%

B) If instead you know that the aftertax cost of debt is 6.1 percent, what is the cost of equity?

• 15.12%
• 36.73%
• 16.83%
• 15.72%
• 14.52%

Answer 1

Ans;

A.)

Debt equity Ratio : 0.84

WACC : 11%

Tax Rate : 32%

WACC = Cost of Equity * Weight of equity + Cost of Debt (1-Tax rate) * Weight of Debt

11% = 15.50% * 1/1.84 + Cost of Debt * 68% * 0.84/1.84

11% = 8.42% + Cost of Debt * 0.31

Cost of Debt : 8.3%

So correct answer is option A.

B.)

Cost of Debt : 6.1%

WACC = Cost of Equity * Weight of equity + Cost of Debt (1-Tax rate) * Weight of Debt

11% = Cost of Equity * 1/ 1.84 + 6.1% * 0.84/1.84

11% = Cost of equity/1.84 + 2.78%

Cost of equity : 15.12%

So correct answer is option A.

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