Kose, Inc., has a target debt-equity ratio of 0.73. Its WACC is 11.5 percent, an
ID: 2618582 • Letter: K
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.
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))
%
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))
Kose, Inc., has a target debt-equity ratio of 0.73. Its WACC is 11.5 percent, and the tax rate is 33 percent.
Explanation / Answer
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).
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