Question

Matroyshka, Inc., has a target debt−equity ratio of 1.3 0. Its WACC is 8. 4 percent, and the tax rate is 40 percent. a. If the company’s cost of equity is 13 percent, what is its pretax cost of debt? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of debt % b. If instead you know that the after-tax cost of debt is 3.7 percent, what is the cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity %

Answer 1

Debt-equity ratio=debt/equity

Hence debt=1.3equity

Let equity be $x

Hence debt=$1.3x

Total=$2.3x

WACC=Respective costs*Respective weights

1.

8.4=(x/2.3x*13)+(1.3x/2.3x*cost of debt)

8.4=5.652173913+(1.3/2.3*cost of debt)

Hence after tax cost of debt=(8.4-5.652173913)*2.3/1.3

=4.86%(Approx)

Hence pretax cost of debt=4.86/(1-tax)

=4.86/(1-0.4)

=8.10%(Approx).

2.

8.4=(x/2.3x*Cost of equity)+(1.3x/2.3x*3.7)

8.4=(x/2.3x*Cost of equity)+(2.091304348)

Hence Cost of equity=(8.4-2.091304348)*2.3

=14.51%