Paget, Inc., has a target debtequity ratio of 1.35. Its WACC is 8.3 percent, and

Question

Paget, Inc., has a target debtequity ratio of 1.35. Its WACC is 8.3 percent, and the tax rate is 35 percent.

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

If instead you know that the aftertax cost of debt is 3.8 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))

Paget, Inc., has a target debtequity ratio of 1.35. Its WACC is 8.3 percent, and the tax rate is 35 percent.

Explanation / Answer

debt + equity = 1

=>

debt = 27/47 , equity = 20/47

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

a)

8.3% = 27/47 * pre tax cost of debt * (1-0.35) + 20/47 * 14%

=>

pretax cost of debt = 6.27%

b)

8.3% = 27/47% * 3.8% + 20/47 * cost of equity

cost of equity = 14.38%

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