Question

# A company has a cost of equity of 13.06% and an unlevered cost of capital of...

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 pre-tax cost of debt?

Question 3 options:

 4.98% 5.11% 5.24% 5.37% 5.50%

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

Debt-Equity Ratio = Value of Debt / Value of Equity
Debt-Equity Ratio = \$16,720 / \$13,004
Debt-Equity Ratio = 1.28576

Levered Cost of Equity = Unlevered Cost of Equity + (Unlevered Cost of Equity - Cost of Debt) * (1 - Tax Rate) * Debt-Equity 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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