A company has a cost of equity of 13.06% and an unlevered cost of capital of 9.22%. The company has $16,720 in debt that is selling at par value. The levered value of the firm is $29,724, and the tax rate is 25%. What is the pretax cost of debt?
Question 3 options:
4.98% 

5.11% 

5.24% 

5.37% 

5.50% 
Answer is 5.24%
Value of Debt = $16,720
Value of Firm = Value of Debt + Value of Equity
$29,724 = $16,720 + Value of Equity
Value of Equity = $13,004
DebtEquity Ratio = Value of Debt / Value of Equity
DebtEquity Ratio = $16,720 / $13,004
DebtEquity Ratio = 1.28576
Levered Cost of Equity = Unlevered Cost of Equity + (Unlevered
Cost of Equity  Cost of Debt) * (1  Tax Rate) * DebtEquity
Ratio
0.1306 = 0.0922 + (0.0922  Cost of Debt) * (1  0.25) *
1.28576
0.0384 = (0.0922  Cost of Debt) * 0.75 * 1.28576
0.0384 = (0.0922  Cost of Debt) * 0.96432
0.0398 = 0.0922  Cost of Debt
Cost of Debt = 0.0524 or 5.24%
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