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? |

(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? |

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).**

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