Question

Kose, Inc., has a target debt-equity ratio of 0.73. Its WACC is 11.5 percent, and the tax rate is 33 percent.

Requirement 1:

If Kose’s cost of equity is 15.5 percent, what is its pretax cost of debt? (Do not include the percent sign (%). Round your answer to 2 decimal places. (e.g., 32.16))

Pretax cost of debt______________

%

Requirement 2:

If instead you know that the aftertax cost of debt is 6.7 percent, what is the cost of equity? (Do not include the percent sign (%). Round your answer to 2 decimal places. (e.g., 32.16))

Cost of equity_____________

%

Answer 1

debt-equity ratio=debt/equity

Hence debt=0.73equity

Let equity be $x

Debt=$0.73x

Total=$1.73x

WACC=Respective costs*Respective weights

1.

11.5=(x/1.73x*15.5)+(0.73x/1.73x*Cost of debt)

11.5=8.959537572+(0.73/1.73*Cost of debt)

Cost of debt=(11.5-8.959537572)*(1.73/0.73)

=6.020547945%(Approx)

Pretax cost of debt=Cost of debt/(1-tax rate)

6.020547945/(1-0.33)

which is equal to

=8.99%(Approx).

2.

11.5=(0.73x/1.73x*6.7)+(x/1.73x*Cost of equity)

Cost of equity=(11.5-2.82716763)*1.73

=15.00%(Approx).