Blue Bull. Inc., has a target debt-equity ratio of.83. Its WACC is 8.7 percent,
ID: 2765584 • Letter: B
Question
Blue Bull. Inc., has a target debt-equity ratio of.83. Its WACC is 8.7 percent, and the tax rate is 38 percent. Required: If the company's cost of equity is 12.3 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).) If the after tax cost of debt is 5.4 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).)Explanation / Answer
Debt Equity Ratio = Debt / Equity = 83/100
Weight of Debt = .83
Weight of equity = 1 - .83 = .17
a) WACC = 8.70% = Rd * Weight of Debt + Re * Weight of Equity
8.70% = Rd *.83 + 12.30% * .17
Rd = 6.609% / .83 = 7.96%
This is after tax cost of debt.
Pre tax cost of debt = 7.96% / 1-.38 = 12.84%
b) WACC = 8.70% = Rd * Weight of Debt + Re * Weight of Equity
8.70% = 5.40% *.83 + Re * .17
Re = 4.218% / .17 = 24.81%