Question

Jungle, Inc., has a target debt—equity ratio of 0.82. Its WACC is 11 percent, and the tax rate is 32 percent.

  

Required:

  

(a)	If Jungle's cost of equity is 14 percent, what is the pretax cost of debt? (Do not round your intermediate calculations.)
	(Click to select)10.8%12.56%11.62%15.21%10.37%

(b)	If instead you know that the aftertax cost of debt is 6 percent, what is the cost of equity? (Do not round your intermediate calculations.)
	(Click to select)15.1%14.5%15.7%17.1%33.78%

Answer 1

Debt-equity ratio=Debt/equity

Hence debt=0.82equity

Let equity be $x

Hence debt=$0.82x

Total=$1.82x

1.

WACC=Respective costs*Respective weights

11=(x/1.82x*14)+(0.82x/1.82x*Cost of debt)

11=7.692307692+(0.82x/1.82x*Cost of debt)

Cost of debt=(11-7.692307692)*1.82/0.82

=7.341463415%

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

=7.341463415/(1-0.32)

which is equal to

=10.8%(Approx).

2.

11=(x/1.82x*Cost of equity)+(0.82x/1.82x*6)

11=(Cost of equity/1.82)+2.703296703

Cost of equity=(11-2.703296703)*1.82

which is equal to

=15.1%