Kose, Inc., has a target debt–equity ratio of 1.35. Its WACC is 8.3 percent, and

Question

Kose, Inc., has a target debt–equity ratio of 1.35. Its WACC is 8.3 percent, and the tax rate is 35 percent.

If Kose’s cost of equity is 14 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))

If instead you know that the aftertax cost of debt is 3.8 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))

Kose, Inc., has a target debt–equity ratio of 1.35. Its WACC is 8.3 percent, and the tax rate is 35 percent.

Explanation / Answer

Debt equity ratio = 1.35

Debt / equity = 1.35

Debt = 1.35 equity

Debt + equity = 1

1.35 equity + equity = 1

2.35 equity = 1

Equity = 0.43

Then, debt = 1- 0.43 = 0.57

a)

Let cost of debt = X

Pretax cost of debt = X*(1-tax) = 0.65X

WACC = weight of equity * cost of equity + weight of debt* cost of debt

8.3 = 0.43 * 14 + 0.57 * 0.65X

2.28 = 0.57 * 0.65X

0.65X = 2.28 / 0.57

X = 4 / .65 = 6.15

b)

Let cost of equity = X

WACC = weight of equity * cost of equity + weight of debt* cost of debt

8.3 = 0.43 * X + 0.57 * 3.8

8.3 - 1.634 = 0.43 * X

6.666 / 0.43 = X

X = 6.666 / 0.43 = 15.50

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