Question

Kose, Inc., has a target debt-equity ratio of 0.7. Its WACC is 10 percent, and the tax rate is 33 percent.

  

If Kose’s cost of equity is 16 percent, what is its pretax cost of debt? (Round your answer to 2 decimal places. (e.g., 32.16))

  

Pretax cost of debt

%

  

If instead you know that the aftertax cost of debt is 7.3 percent, what is the cost of equity? (Round your answer to 2 decimal places. (e.g., 32.16))

  

Cost of equity

%

Answer 1

1

D/A = D/(E+D)

D/A = 0.7/(1+0.7)

=0.4118

Weight of equity = 1-D/A

Weight of equity = 1-0.4118

W(E)=0.5882

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

10=after tax cost of debt*0.4118+16*0.5882

after tax cost of debt = 1.4284

pretax cost of debt =

after tax cost of debt/(1-tax rate) = 1.4284/(1-0.33) = 2.13%

part 2

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

10=7.3*0.4118+cost of equity*0.5882

cost of equity=11.89%