Question

10

Kose, Inc., has a target debt-equity ratio of .49. Its WACC is 9.5 percent, and the tax rate is 21 percent.

a.	If the company’s cost of equity is 12 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 5.3 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

Debt-equity ratio=Debt/equity

Hence debt=0.49 equity

Let equity be $x

Hence debt=$0.49x

Total=$1.49x

WACC=Respective costs*Respective weight

1.

9.5=(x/1.49x*12)+(0.49x/1.49x*Cost of debt)

9.5=8.053691275+(0.49/1.49*Cost of debt)

Cost of debt=(9.5-8.053691275)*(1.49/0.49)

=4.397959184%

Hence pre-tax Cost of debt=Cost of debt/(1-tax rate)

=4.397959184/(1-0.21)

=5.57%(Approx).

2.

9.5=(x/1.49x*Cost of equity)+(0.49x/1.49x*5.3)

9.5=(1/1.49*Cost of equity)+1.74295302

Cost of equity=(9.5-1.74295302)*1.49

=11.56%(Approx).