Problem 12-14 WACC CLO 3] Blue Bull, Inc., has a target debt-equity ratio of .81

Question

Problem 12-14 WACC CLO 3] Blue Bull, Inc., has a target debt-equity ratio of .81. lts 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

Debt Equity ratio 0.81 Debt = .81 Equity Debt + Equity = 1 .81 Equity + Equity =1 1.81 Equity = 1 Equity =1/1.81 Equity =.5525 Debt = 1 - .5525 Debt = .4475 Let cost of debt be x Particulars Weight Cost of capital Weighted cost of capital Equity 0.5525 12.10% 6.69% Debt 0.4475 x .4475X 1 6.69% + .4475x 6.69% +.4475x = 8.5% .4475x = 1.81% x = kd = 4.0447% Tax Rate = 34% Pre tax cost of debt = 4.0447%/(1-..34) Pre tax cost of debt = 6.13% let cost of equity be x Particulars Weight Cost of capital Weighted cost of capital Equity 0.5525 x .5525x Debt 0.4475 5.20% 2.33% 1 2.33% + .5525x 2.33% +.5525x = 8.5% .5525x = 6.17% x = ke = 11.17%

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