Blue Bull, Inc., has a target debt-equity ratio of .81. Its WACC is 8.5 percent,

Question

Blue Bull, Inc., has a target debt-equity ratio of .81. Its WACC is 8.5 percent, and the tax rate is 34 percent. Required: (a) If the company’s cost of equity is 12.1 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 % (b) If the aftertax cost of debt is 5.2 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 %

Explanation / Answer

(a) If the company’s cost of equity is 12.1 percent than its pretax cost of debt is 4.045 %.

WACC = 8.5%, Debt Eaquity ratio = 0.81, Tax rate = 0.34

WACC= Cost of Debt *0.81/1.81 + 0.121 *(1/1.81)

0.085 = Cost of Debt *0.81/1.81 + 0.121 *(1/1.81)

0.085= Cost of Debt  *0.4475 +0.0669

Cost of Debt*0.4475 = 0.085-0.0669

Cost of Debt*0.4475 =0.0181

Cost of Debt = 0.0181/*0.29535

Cost of Debt = 0.04045 or 4.045 %

pretax cost of debt= 4.045%

(b) If the aftertax cost of debt is 5.2 percent, what is the cost of equity?

before tax cost of debt is 0.052/0.66 = 0.0788 or 7.88%

WACC = Cost of Equity *1/1.81 + 0.0788/ *0.81/1.81

0.085 = Cost of Equity*0.5525 + 0.0353

Cost of Equity=0.085-0.0353/0.5525

  Cost of Equity = 0.0899 8.99%

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