Question

6. Sierra Inc has a capital structure of 30% debt and 70% common equity, with no preferred stock. With a cost of retained earnings of 13%, a tax rate of 40%, find the cost of debt, rd, given a WACC of 9.96%.

Answer 1

Solution:
	The cost of debt ( rd ) = 4.78%
Working Notes:
	WACC= (Wd)(rd)(1 – T) + (We)(rs)
	WACC= 9.96%
	weight of debt (Wd)=30%
	Weight of equity (We)= 70%
	cost of debt ( rd )=??
	T = tax rate = 40%
	rs = cost of equity = 13%
	WACC= (Wd)(rd)(1 – T) + (We)(rs)
	9.96% = 30% x rd x (1-.40) + 70% x 13%
	9.96% = 30% x rd x 0.60 + 70% x 13%
	9.96% = 18% x rd + 9.1%
	rd = (9.96% - 9.1%)/18%
	rd=0.04777
	rd =4.78%
let check it
	WACC= (Wd)(rd)(1 – T) + (We)(rs)
	=0.30 x 4.78% x 0.60 + 0.70 x 13%
	= 9.9604
	=9.96%
Please feel free to ask if anything about above solution in comment section of the question.