Kose, Inc., has a target debt–equity ratio of 1.60. Its WACC is 7.8 percent, and

Question

Kose, Inc., has a target debt–equity ratio of 1.60. Its WACC is 7.8 percent, and the tax rate is 40 percent. a. If the company’s cost of equity is 16 percent, what is its pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of debt % b. If instead you know that the aftertax cost of debt is 4.3 percent, what is the cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Cost of equity %

Explanation / Answer

Let the equity be1 ,so debt will be 1.6 ,So total 1+1.6= 2.6

Weight of debt : 1.6/2.6 = .6154

Weight of equity : 1/2.6 = .3846

A)WACC= [Pretax cost of debt(1-Tax)*Weight of debt]+[Cost of equity *Weight of equity]

7.8 =[ x(1-.40)*.6154]+[16*.3846]

7.8 = [x*.60*.6154]+6.1536

   7.8-6.1536 = .36924 x

     x = 1.6464/.36924

       = 4.46%

pretax cost of debt 4.46%

b)7.8 = [4.3*.6154]+[cost of equity*.3846]

7.8 = 2.6462+ .3846 y

7.8-2.6462 = .3846y

y = 5.1538/.3846

      = 13.40%

cost of equity =13.40%

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