Starset, Inc., has a target debt-equity ratio of 0.81. Its WACC is 11.5 percent, and the tax rate is 35 percent. |
If the company's cost of equity is 15 percent, what is the pretax cost of debt? |
If instead you know that the aftertax cost of debt is 7 percent, what is the cost of equity? |
Debt-equity ratio=debt/equity
Hence debt=0.81*equity
Let equity be $x
Debt=$0.81x
Total=$1.81x
WACC=Respective cost*Respective weight
a.
11.5=(x/1.81x*15)+(0.81x/1.81x*Cost of debt)
11.5=8.28729282+(0.81x/1.81x*Cost of debt)
Cost of debt=(11.5-8.28729282)*1.81/0.81
=7.17901234%
Pre-tax Cost of debt=Cost of debt/(1-tax rate)
=7.17901234/(1-0.35)
=11.04%(Approx)
b.
11.5=(x/1.81x*Cost of equity)+(0.81x/1.81x*7)
11.5=(x/1.81x*Cost of equity)+3.13259669
Cost of equity=(11.5-3.13259669)*1.81
=15.145%
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