Blue Bull, Inc., has a target debt-equity ratio of .78. Its WACC is 8.7 percent,

Question

Blue Bull, Inc., has a target debt-equity ratio of .78. Its WACC is 8.7 percent, and the tax rate is 38 percent. Required: If the company's cost of equity is 11.8 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 cos! of debt If the aftertax cost of debt is 6 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 equality

Explanation / Answer

Debt equity ratio = 0.78 or 78/100 , therefore total value(Debt + Equity) = 78 + 100 = 178

WACC = equity / (debt + equity) * ke + Debt / (debt + equity) * kd

(a)    WACC = equity / (debt + equity) * ke + Debt / (debt + equity) * kd

WACC = 100 / 178 * 0.118 + 78 /178 *  kd

0.087 = 0.066 + 78/178* kd

0.021 = 78/178* kd

kd   = 4.79%

(b)    WACC = equity / (debt + equity) * ke + Debt / (debt + equity) * {kd * (1- Tax)}

  0.087 = 100/178 * ke + 78/178 * 0.06

0.087 = 100/178 * ke + 0.026

   0.061 = 100/178 * ke

   k e = 10.86%

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