Paget, Inc., has a target debt-equity ratio of 1.45. Its WACC is 9.6 percent, an

Question

Paget, Inc., has a target debt-equity ratio of 1.45. Its WACC is 9.6 percent, and the tax rate is 38 percent. a. If the company?s cost of equity is 13 percent, what is its pretax cost of debt? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Cost of debt b. If instead you know that the aftertax cost of debt is 5.6 percent, what is the cost of equity? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Cost of equity %

Explanation / Answer

debt equity ratio = 1.45

debt weights = 1.45/(1.45+1) = 0.591837

equity weights = 1/(1.45+1) = 0.408163

WACC = aftertax cost of debt*debt weights + cost of equity*equity weights

= pretax cost of debt*(1-tax rate)*debt weights + cost of equity*equity weights

(a)

9.6% = pretax cost of debt*(1-38%)*0.591837 + 13%*0.408163

pretax cost of debt = 11.70%

(b)

9.6% = 5.6%*0.591837 + cost of equity*0.408163

cost of equity = 15.4%

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