Question

Kose, Inc., has a target debt-equity ratio of 1.63. Its WACC is 7.4 percent, and the tax rate is 25 percent.

a. If the company’s cost of equity is 15 percent, what is its pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

b. If instead you know that the aftertax cost of debt is 5.6 percent, what is the cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Ans:

Debt Equity Ratio : 1.63

WACC : 7.4%

Tax Rate : 25%

a.

Cost of Equity : 15%

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

7.4 = 15 * 1.00/2.63 + Cd * 1.63/2.63 (1-25%)

Cost of Debt (Cd) = 3.65%

b.

After tax cost of Debt : 5.60%

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

7.4 = Cost of Equity * 1/2.63 + 5.60*1.63/2.63

Cost of equity = 10.33%

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