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Week 8 Bermuda Cruises issues only common stocks and coupon bonds. The firm has a debt-equity...

Week 8 Bermuda Cruises issues only common stocks and coupon bonds. The firm has a debt-equity ratio of 0.45. The cost of equity is 17.6 percent. Required: What is the pre-tax cost of the company debt if weighted average costs of the company is 13.5% and the firm's tax rate is 35 percent?

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Answer #1

Solution:-

Total Capital = Debt + Equity

Total Capital = 0.45 + 1 = 1.45

Debt Weight =

Debt Weight = 0.3103

Equity Weight =

Equity Weight = 0.6897

To Calculate Pre-tax Cost of debt-

WACC = Cost of debt * weight of debt + Cost of Equity * Weight of Equity

0.135 = Cost of debt * 0.3103 + 0.176 * 0.6897

0.135 = Cost of debt * 0.3103 + 0.1214

0.135 - 0.1214 = Cost of debt * 0.3103

0.0136 = Cost of debt * 0.3103

Cost of Debt =

Cost of Debt = 4.38%

Pre-Tax Cost of debt =

Pre-Tax Cost of debt =

Pre-Tax Cost of debt = 6.74%

If you have any query related to question then feel free to ask me in a comment.Thanks.

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