Question

Starset, Inc., has a target debt-equity ratio of 1.15. Its WACC is 8.3 percent, and the tax rate is 22 percent. a. If the company’s cost of equity is 12 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.) b. If instead you know that the aftertax cost of debt is 5.9 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.)

Answer 1

Answer:

a. 6.52%

b. 11.06%

Explanation:

For determining the pretax cost of debt, first we have to first find out the after cost of  debt which is

As we know that

WACC = Weighted × cost of debt + Weighted ×  cost of equity

8.3% = (1.15 ÷ 2.15) × cost of debt +  (1.15 ÷ 2.15) × 12%

So after solving this the cost of debt is 5.08%

The 2.15 is come from 1 + 1.15

So the pre tax cost of debt is

= 5.08%  ÷ (1 - 0.22)

= 6.52%

b. WACC = Weighted × cost of debt + Weighted ×  cost of equity

8.3% = (1.15 ÷ 2.15) × 0.059+  (1 ÷ 2.15) × cost of equity

After solving this, the cost of equity is 11.06%