Question

Fyre, Inc., has a target debt−equity ratio of 1.80. Its WACC is 8.7 percent, and the tax rate is 40 percent.

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

Cost of debt

%

b.	If instead you know that the aftertax cost of debt is 7.1 percent, what is the cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Cost of equity

%

Fyre, Inc., has a target debt−equity ratio of 1.80. Its WACC is 8.7 percent, and the tax rate is 40 percent.

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

Cost of debt

%

b.	If instead you know that the aftertax cost of debt is 7.1 percent, what is the cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Cost of equity

%

Answer 1

Solution : -

WACC = Weight Debt * Pre tax Cost of Debt * ( 1 - tax ) + Weight of Equity * Cost of Equity

WACC = 8.7%

Debt - Equity Ratio = 1.80

Weight of Debt = 1.80 / ( 1 + 1.80 ) = 1.80 / 2.80

Weight of Equity = 1.00 / 2.80

(A)

Cost of Equity = 15%

Now Pre tax Cost of Debt =  

8.7% = Pre tax Cost of Debt * ( 1 - 0.40 ) * (1.8 / 2.8) + 15% * ( 1 / 2.80 )

8.7% =

Pre tax Cost of Debt * 0.3857 = 8.7% - 5.357%

Pre tax Cost of Debt = 8.67%

(B)

After tax Cost of Debt = 7.1%

Then Cost of Equity =

8.7% = 7.1% * (1.8 / 2.8) + Cost of Equity * ( 1 / 2.80 )

Cost of Equity * ( 1 / 2.80 ) = 4.136%

Cost of Equity = 11.58%

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