Fyre, Inc., has a target debtequity ratio of 1.60. Its WACC is 7.8 percent, and
ID: 2770372 • Letter: F
Question
Fyre, Inc., has a target debtequity ratio of 1.60. Its WACC is 7.8 percent, and the tax rate is 40 percent. If the company’s cost of equity is 16 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 4.3 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.)
Explanation / Answer
Let the weighted cost of debt be W.
Therefore, 0.0780 = 0.0615 + W or W = 0.0165
If the After tax cost of debt is C, then 0.6154C = 0.0165 or C = 2.68%
If the tax rate is 40%, pre-tax cost of debt is 2.68 / 60% = 4.47%
If after tax cost of debt is 4.3%, then 0.6154 x 0.043 + 0.3846 Ke = 0.078
Ke or Cost of equity is 13.4 %
Source of capital Target debt-equity ratio Weights Specific cost of capital Weighted cost Debt 1.60 0.6154 ? ? Equity 1.0 0.3846 0.16 0.0615 2.60 1.000 0.0780Related Questions
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