Question

Kose, Inc., has a target debt-equity ratio of 1.55. Its WACC is 7.9 percent, and the tax rate is 23 percent.

a.	If the company’s cost of equity is 13 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.)
b.	If instead you know that the aftertax cost of debt is 4.8 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.)

Answer 1

a

D/A = D/(E+D)

D/A = 1.55/(1+1.55)

=0.6078

Weight of equity = 1-D/A

Weight of equity = 1-0.6078

W(E)=0.3922

Weight of debt = D/A

Weight of debt = 0.6078

W(D)=0.6078

Weight of Equity = 0.3922

Weight of Debt = 0.6078

Cost of Capital = Weight of Equity*Cost of Equity+Weight of Debt*Cost of Debt

7.9 = 13*0.3922+Cost of Debt*0.6078

Cost of Debt = 4.6091

4.6091 = YTM * (1-0.23)

YTM = 5.99 = pre tax cost of debt

b

Cost of Capital = Weight of Equity*Cost of Equity+Weight of Debt*Cost of Debt

7.9 = Cost of Equity*0.3922+4.8*0.6078

Cost of Equity = 12.70%