Paget, Inc., has a target debtequity ratio of 1.70. Its WACC is 8.9 percent, and
ID: 2718702 • Letter: P
Question
Paget, Inc., has a target debtequity ratio of 1.70. Its WACC is 8.9 percent, and the tax rate is 35 percent.
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))
If instead you know that the aftertax cost of debt is 6.9 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 1.70. Its WACC is 8.9 percent, and the tax rate is 35 percent.
Explanation / Answer
a) Debt Equity Ratio = Debt /Equity 1.70 = Debt/Equity Debt = 1.70Equity Particulars Investment Weight a Cost b WACC a*b Debt 1.70 0.6296 x .63x Equity 1.00 0.3704 13.00% 4.81% 2.70 1.00 8.9% = 4.81% + .6296x 4.09% =.6296x x=6.5% Pretax cost of debt = 6.5/(1-.35) = 10% b) Particulars Investment Weight a Cost b WACC a*b Debt 1.70 0.6296 6.90% 4.34% Equity 1.00 0.3704 x .3704x 2.70 1.00 8.9% = .3704x + 4.34% 4.56% =.3704x x=12.31% Cost of Equity = 12.31%
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