Kose, Inc., has a target debt–equity ratio of 1.45. Its WACC is 8.1 percent, and
ID: 1175349 • Letter: K
Question
Kose, Inc., has a target debt–equity ratio of 1.45. Its WACC is 8.1 percent, and the tax rate is 40 percent.
If the company’s cost of equity is 16 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.)
If instead you know that the aftertax cost of debt is 4.0 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.)
Kose, Inc., has a target debt–equity ratio of 1.45. Its WACC is 8.1 percent, and the tax rate is 40 percent.
Explanation / Answer
Debt-equity ratio=Debt/Equity
Hence debt=1.45equity
Let equity be $x
Hence debt=$1.45x
Total=$2.45x
WACC=Respective costs*Respective weights
1.
8.1=(x/2.45x*16)+(1.45x/2.45x*Cost of debt)
8.1=6.530612245+0.591836734*Cost of debt
Cost of debt=(8.1-6.530612245)/0.591836734
Cost of debt=2.651724138%(Approx)
Pretax Cost of debt=2.651724138/(1-tax rate)
2.651724138/(1-0.4)
=4.42%(Approx).
2.
8.1=(x/2.45x*Cost of equity)+(1.45x/2.45x*4)
8.1=(0.408163265*Cost of equity)+2.367346939
Cost of equity=(8.1-2.367346939)/0.408163265
=14.05%(Approx).
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