Fyre, Inc., has a target debtequity ratio of 1.50. Its WACC is 8 percent, and th
ID: 2756869 • Letter: F
Question
Fyre, Inc., has a target debtequity ratio of 1.50. Its WACC is 8 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. 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 4.1 percent, what is the cost of equity? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Fyre, Inc., has a target debtequity ratio of 1.50. Its WACC is 8 percent, and the tax rate is 35 percent.
Explanation / Answer
a) WACC for Fyre Inc is given by 0.6*Kd + 0.4*Ke, where Kd is after tax cost of debt and Ke cost of equity.
weights of debt and equity are 1.5/2.5 and 1/2.5 = 0.6 and 0.4
given Ke = 14%,
8 = 0.6*Kd + 0.4*14; 8 - 5.6 = 0.6 Kd; Kd = 2.4/0.6 = 4%
Therefore, Pre-tax Kd = 4/0.65 = 6.15 %
2) We have 8 = 0.6 * 4.1 + 0.4 * Ke; 8 = 2.46 + 0.4Ke; 8-2.46/0.4 = Ke; Ke =13.85
Therefore, Cost of equity =13.85%
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