Question

Jungle, Inc., has a target debt—equity ratio of 0.81. Its WACC is 11.5 percent, and the tax rate is 33 percent.

  

Required:

  

(a)	If Jungle's cost of equity is 16.5 percent, what is the pretax cost of debt? (Do not round your intermediate calculations.)
	(Click to select)8.69%15.41%7.95%11.12%7.61%

(b)	If instead you know that the aftertax cost of debt is 5.7 percent, what is the cost of equity? (Do not round your intermediate calculations.)

Answer 1

Debt-equity ratio=debt/equity

Hence debt=0.81equity

Let equity be $x

Hence debt=$0.81x

Total=$1.81x

WACC=Respective costs*respective weights

a.

11.5=(x/1.81x*16.5)+(0.81x/1.81x*Cost of debt)

11.5=9.116022099+0.447513812Cost of debt

Cost of debt=(11.5-9.116022099)/0.447513812

=5.327160497%

Hence pretax Cost of debt=Cost of debt/(1-tax rate)

=5.327160497/(1-0.33)

which is equal to

=7.95%(Approx).

b.

11.5=(x/1.81x*Cost of equity)+(0.81x/1.81x*5.7)

11.5=0.552486187Cost of equity+2.550828729

Cost of equity=(11.5-2.550828729)/0.552486187

which is equal to

=16.20%(Approx).