Fyre, Inc., has a target debtequity ratio of 1.55. Its WACC is 7.9 percent, and
ID: 2803562 • Letter: F
Question
Fyre, Inc., has a target debtequity ratio of 1.55. Its WACC is 7.9 percent, and the tax rate is 38 percent.
a. If the company’s cost of equity is 15 percent, what is its pretax cost of debt? (Do not round intermediate calculations. 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 4.2 percent, what is the cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Cost of equity %
NO EXCEL SOLUTIONS PLEASE!
Explanation / Answer
Debt-equity ratio=Debt/Equity
Hence debt=1.55Equity
Let equity be $x
Hence debt=$1.55x
Total=$2.55x
WACC=Respective costs*Respective investment weight
1.
7.9=(x/2.55x*15)+(1.55x/2.55x*Cost of debt)
7.9=5.882352941+(1.55/2.55Cost of debt)
Hence Cost of debt=(7.9-5.882352941)*2.55/1.55
=3.319354839
Hence pretax cost of debt =3.319354839/(1-tax rate)
=3.319354839/(1-0.38)
=5.35%(Approx)
b.
7.9=(x/2.55x*Cost of equity)+(4.2*1.55x/2.55x)
7.9=(Cost of equity/2.55)+2.552941176
Hence cost of equity=(7.9-2.552941176)*2.55
=13.64%(Approx).
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