Starset, Inc., has a target debt-equity ratio of .70. Its WACC is 9.2 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 5.7 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.) |
debt-equity ratio=debt/equity
Hence debt=0.7equity
Let equity be $x
Debt=$0.7x
Total=$1.7x
WACC=Respective cost*Respective weight
1.
9.2=(x/1.7x*12)+(0.7x/1.7x*Cost of debt)
9.2=7.058823529+(0.7/1.7*Cost of debt)
Cost of debt=(9.2-7.058823529)*(1.7/0.7)
=5.2%
Hence pretax cost of debt=Cost of debt/(1-tax rate)
=5.2/(1-0.21)
=6.58%(Approx).
2.
9.2=(x/1.7x*Cost of equity)+(0.7x/1.7x*5.7)
9.2=(1/1.7*Cost of equity)+2.347058824
Cost of equity=(9.2-2.347058824)*1.7
=11.65%
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