Question

David Ortiz Motors has a target capital structure of 40% debt and 60% equity. The yield to maturity on the company's outstanding bonds is 9%, and the company's tax rate is 40%. Ortiz's CFO has calculated the company's WACC as 10.15%. What is the company's cost of equity capital? Round your answer to two decimal places.

Answer 1

Step-1:Calculation of after tax cost of debt
	Yield to maturity on bond is the cost of debt.
	After tax cost of debt			=	Before Tax Cost of debt*(1-Tax Rate)
				=	9%*(1-0.40)
				=	5.40%
Step-2:Calculation of Cost of Equity
	WACC	=	(Weight of debt*After tax cost of debt)+(Weight of Equity*Cost of Equity)
or,	10.15%	=	(40%*5.40%)+(60%*Cost of Equity)
or,	10.15%	=	2.16%+(60%*Cost of Equity)
or,	7.99%	=	60%*Cost of Equity
or,	Cost of Equity	=	13.32%
Thus,
Cost of Equity is 13.32%