Jungle, Inc., has a target debt—equity ratio of 0.71. Its WACC is 10.5 percent,
ID: 2728970 • Letter: J
Question
Jungle, Inc., has a target debt—equity ratio of 0.71. Its WACC is 10.5 percent, and the tax rate is 35 percent. Required: (a) If Jungle's cost of equity is 14.5 percent, what is the pretax cost of debt? (Do not round your intermediate calculations.) options: 7.49, 8.21, 13.364, 11.78, 7.16 (b) If instead you know that the aftertax cost of debt is 6.2 percent, what is the cost of equity? (Do not round your intermediate calculations.) options: 13.01, 16.36, 13.55, 14.1, 21.03 please show how you got to answer
Explanation / Answer
Debt-Equity Ratio = 0.71
So, Proportion of debt = 0.71/(1+0.71) = 0.4152 or 41.52%
Proportion of equity = 1-0.4152 = 0.5748 or 57.48%
WACC = (Weight of debt x After tax cost of debt) + (Weight of equity x cost of equity)
=> 0.105 = (0.4152 x After tax cost of debt) + (0.5748 x 0.145)
=> After tax cost of debt = 0.052153
Pre-tax cost of debt = (0.052153/65) x 100 = 8.21%
When after tax cost of debt is 6.2% then cost of equity
=> 0.105 = (0.062 x 0.4152) + (Cost of equity x 0.5748)
Cost of equity = 13.55%