Kose, Inc., has a target debt–equity ratio of 1.40. Its WACC is 8.3 percent, and
ID: 2721760 • Letter: K
Question
Kose, Inc., has a target debt–equity ratio of 1.40. Its WACC is 8.3 percent, and the tax rate is 38 percent. a. If Kose’s cost of equity is 15 percent, what is its pretax cost of debt? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Cost of debt=???? %
b. If instead you know that the aftertax cost of debt is 3.9 percent, what is the cost of equity? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Cost of equity=??? %
Explanation / Answer
Let the debt be x Equity =y x/y = 1.4 x+y = 1 1.4y+y = 1 y = 1/2.4 y = 42% X = 0.58 Now 8.3 = .42*15+.58*cost of debt(1-.38) 8.3= 6.3+.36 x .36x = 2 Cost of debt = 2/.36 5.56% Cost of debt is 5.56% b If after tax cost of debt is 3.9 percent 8.3 = cost of equity*.42+.58*3.9*(1-.38) 8.3 .42x+1.40 .42x = 6.9 x = 6.9/.42 16.42857 Cost of Equity = 16.43%
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