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Can you please provide a step by step instruction to get to the answer to the...

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Finance

Can you please provide a step by step instruction to get to theanswer to the following question WACC. Kose, Inc., has a targetdebt-equity ratio of .38. Its WACC is 10.1 percent and the tax rateis 25 percent. a) If the company’s cost of equity is 12 percent,what is its pretax cost of debt? b) If instead you know that theaftertax cost of debt is 6.4 percent, what is the cost ofequity?

Answer & Explanation Solved by verified expert
4.5 Ratings (893 Votes)

Weighted average cost of capital (WACC) = [(S/S+B)*Rs + (B/S+B)*Rb(1-tc)]
S = equity, B = debt, Rs = Cost of equity, Rb = cost of debt,
tc = corporations tax rate
a) Rs 0.12
WACC 0.101
tc 0.25
B/S 0.38
B .38S
S+B 1.38S
S/(S+B) S/1.38S
S/(S+B) 0.7246
B/(S+B) 1 - (S/(S+B))
B/(S+B) 0.2754
0.101 .7246*.12 + .2754*Rb*(1-.25)
0.101 .7246*.12 + .2754*Rb*(.75)
.2754*Rb*(.75) = .101 - (.7246*.12)
.20655*Rb = .014048
Rb = .014048/.20655
Rb = .068
The pre-tax cost of debt is equal to 6.8%.
b) Rb*(1-tc) 0.064
WACC 0.101
B/S 0.38
B .38S
S+B 1.38S
S/(S+B) S/1.38S
S/(S+B) 0.7246
B/(S+B) 1 - (S/(S+B))
B/(S+B) 0.2754
0.101 .7246*Rs + .2754*.064
.7246*Rs+0.017626 0.101
.7246*Rs 0.0833744
Rs .0833744/.7246
Rs 0.115062655
Rs 11.51%
The cost of equity is equal to 11.51%.

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