Blue Bull, Inc., has a target debt-equity ratio of .84. Its WACC is 8.8 percent,

Question

Blue Bull, Inc., has a target debt-equity ratio of .84. Its WACC is 8.8 percent, and the tax rate is 40 percent.

If the aftertax cost of debt is 5 percent, what is the cost of equity?

If the company’s cost of equity is 12.4 percent, what is its pretax cost of debt?

Blue Bull, Inc., has a target debt-equity ratio of .84. Its WACC is 8.8 percent, and the tax rate is 40 percent.

If the aftertax cost of debt is 5 percent, what is the cost of equity?

If the company’s cost of equity is 12.4 percent, what is its pretax cost of debt?

Explanation / Answer

WACC = Wd×Rd×(1-t)+We×Ke

W is weights of respective portfolios

R is return on respective portfolios

0.088 = (0.84÷1.84)×0.05+(1÷1.84)×Ke

Cost of equity, Ke = 12%

0.088 = (0.84÷1.84)× Rd×(1-0.40)+(1÷1.84)×0.124

Pre-tax cost of debt, Rd = 7.5%

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