Kose Inc has a target debtequity ratio of 175 Its WACC is 88

Kose, Inc., has a target debt–equity ratio of 1.75. Its WACC is 8.8 percent, and the tax rate is 38 percent.

If the company’s cost of equity is 14 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.)

If instead you know that the aftertax cost of debt is 7.0 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.)

Solution

Debt-equity ratio=Debt/Equity

Hence debt=1.75equity

Let equity be $x

Hence debt=$1.75x

Total=$2.75x

WACC=Respective costs*Respective weights

1.

8.8=(1.75x/2.75x*Cost of debt)+(x/2.75x*14)

8.8=(0.63636Cost of debt)+(5.09091)

Cost of debt=(8.8-5.09091)/0.63636

=5.8286%(Approx)

Hence pretax cost of debt=Cost of debt/(1-tax rate)

=5.8286/(1-0.38)

=9.40%(Approx)

b.

8.8=(7*1.75x/2.75x)+(Cost of equity*x/2.75x)

Cost of equity=(8.8-4.4545)*2.75

=11.95%.