Question

Kose, Inc., has a target debt–equity ratio of 1.45. Its WACC is 8.1 percent, and the tax rate is 40 percent.

a.	If the company’s cost of equity is 16 percent, what is its pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Cost of debt

%

b.	If instead you know that the aftertax cost of debt is 4.0 percent, what is the cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

  Cost of eq

Answer 1

Debt-equity ratio=Debt/Equity

Hence debt=1.45equity

Let equity be $x

Hence debt=$1.45x

Total=$2.45x

WACC=Respective costs*Respective weights

1.

8.1=(x/2.45x*16)+(1.45x/2.45x*Cost of debt)

8.1=6.530612245+0.591836734*Cost of debt

Cost of debt=(8.1-6.530612245)/0.591836734

Cost of debt=2.651724138%(Approx)

Pretax Cost of debt=2.651724138/(1-tax rate)

2.651724138/(1-0.4)

=4.42%(Approx).

2.

8.1=(x/2.45x*Cost of equity)+(1.45x/2.45x*4)

8.1=(0.408163265*Cost of equity)+2.367346939

Cost of equity=(8.1-2.367346939)/0.408163265

=14.05%(Approx).