Question

# Jungle, Inc., has a target debt—equity ratio of 0.72. Its WACC is 11 percent, and the...

Jungle, Inc., has a target debt—equity ratio of 0.72. Its WACC is 11 percent, and the tax rate is 33 perce

 (a) If Jungle's cost of equity is 16.5 percent, what is the pretax cost of debt? (Do not round your intermediate calculations.)

 (b) If instead you know that the aftertax cost of debt is 7.3 percent, what is the cost of equity? (Do not round your intermediate calculations.)

debt—equity ratio=debt/equity

Hence debt=0.72equity

Let equity be \$x

Debt=\$0.72x

Total assets=debt+equity

=1.72equity

WACC=Respective costs*Respective investment weights

1.

0.11=(x/1.72x*0.165)+(0.72x/1.72x*Cost of debt)

0.11=0.095930232+(0.72/1.72*Cost of debt)

Cost of debt=(0.11-0.095930232)*1.72/0.72

=0.033611(Approx)

Hence pretax cost of debt=0.033611/(1-0.33)

=5.02%(Approx).

2.

0.11=(x/1.72x*Cost of equity)+(0.72x/1.72x*0.073)

Cost of equity=(0.11-0.030558139)*1.72

=13.66%(Approx).

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