Clifford, Inc., has a target debt-equity ratio of.83. Its WACC is 8.7 percent, a

Question

Clifford, Inc., has a target debt-equity ratio of.83. Its WACC is 8.7 percent, and the tax rate is 38 percent. a. If the company's cost of equity is 12.3 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.) Pretax cost of debt b. If the aftertax cost of debt is 5.4 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

Debt-equity ratio=Debt/Equity

Hence debt=0.83Equity

Let equity be $x

Debt=$0.83x

Total=$1.83x

WACC=Respective costs*Respective weigjts

1.

0.087=(0.123*x/1.83x)+(Cost of debt*0.83x/1.83x)

(0.087-0.067213114)*(1.83/0.83)=Cost of debt

Hence cost of debt=0.043626506

Hence pretax cost of debt=0.043626506/(1-0.38)

=7.04%(Approx)

2.

0.087=(Cost of equity*x/1.83x)+(0.054*0.83x/1.83x)

Hence cost of equity=(0.087-0.024491803)*1.83

=11.44%(Approx)

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