Blue Bull, Inc., has a target debt-equity ratio of .84. Its WACC is 8.8 percent,
ID: 2750998 • Letter: B
Question
Blue Bull, Inc., has a target debt-equity ratio of .84. Its WACC is 8.8 percent, and the tax rate is 40 percent.
If the aftertax cost of debt is 5 percent, what is the cost of equity?
If the company’s cost of equity is 12.4 percent, what is its pretax cost of debt?
Blue Bull, Inc., has a target debt-equity ratio of .84. Its WACC is 8.8 percent, and the tax rate is 40 percent.
If the aftertax cost of debt is 5 percent, what is the cost of equity?
If the company’s cost of equity is 12.4 percent, what is its pretax cost of debt?
Explanation / Answer
WACC = Wd×Rd×(1-t)+We×Ke
W is weights of respective portfolios
R is return on respective portfolios
0.088 = (0.84÷1.84)×0.05+(1÷1.84)×Ke
Cost of equity, Ke = 12%
0.088 = (0.84÷1.84)× Rd×(1-0.40)+(1÷1.84)×0.124
Pre-tax cost of debt, Rd = 7.5%