value 1.00 points Blue Bull, Inc., has a target debt-equity ratio of .82. Its WA

Question

value 1.00 points Blue Bull, Inc., has a target debt-equity ratio of .82. Its WACC is 8.6 percent, and the tax rate is 30 percent. Required: (a) If the company?s cost of equity is 12.2 percent, what is its pretax cost of debt?(Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) Pretax cost of debt 7.80 % (b) If the after tax cost of debt is 5.3 percent, what is the cost of equity? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) Cost of equity 18,33 %

Explanation / Answer

(a) WACC = weight of equity in capital*cost of capital + weight of debt in capital* post tax cost of debt

Debt:equity = 0.82. So total capital = 0.82+1 = 1.82

Weight of equity in capital = 1/1.82 = 54.95%

Weight of debt in capital = 100-54.95 = 45.05%

WACC = 8.6%. Cost of equity = 12.2%

Putting these values in the WACC formula

8.6% = 54.95% of 12.2+45.05% of cost of debt

8.6% = 6.7% + 45.05% of cost of debt

1.9% = 45.05% of cost of debt

or cost of debt = 4.21%

This is the post tax cost. Tax rate = 30%.

Thus pre tax cost of debt = 4.21/(100-30) = 6.02%

(b) WACC = 8.6%. After tax cost of debt = 5.3%

Putting these values in WACC formula,

8.6% = 54.95% of cost of equity+45.05% of 5.3

8.6% - 2.4% = 54.95% of cost of equity

cost of equity = 6.2/.5495 = 11.28%

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