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

a. WACC = [Cost of debt * (1 - tax rate) * debt-equity ratio + Cost of equity] / (debt-equity ratio + 1)

=> 8.3% = [Cost of debt * (1 - 35%) * 1.35 + 14%] / (1.35 + 1)

=> Cost of debt = 6.27%

b. WACC = [After tax cost of debt * debt-equity ratio + Cost of equity] / (debt-equity ratio + 1)

=> 8.3% = [3.8% * 1.35 + Cost of equity] / (1.35 + 1)

=> Cost of equity = 14.38%

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