cost of debt

QUESTION

Kose, Inc. has a target debt-equity ratio of 1.40. Its WACC is 8.3 percent, and the tax rate is 38%.If Koses cost of equity is 15%, what is the pre-tax cost of debt? (final answer should be rounded to 2 decimal places)If instead you know that the aftertax cost of debt is 3.9%, what is the cost of equity? (answer should be rounded to 2 decimal places)
Concept: Weighted average cost of capital can be calculated as: WACC = Weighted Cost of Equity + Weighted Cost of Debt (after tax) = Weight of Equity*Cost of Equity + Weight of debt *Cost of debt (after tax) Solution: For Kose, Inc.: Debt-Equity Ratio = 1.40 So, Total Debt = 1.40*Total Equity Total Assets = Total Debt + Total Equity = (1.40 + 1)*Total Equity Weight of Equity = Total Equity/Total Assets = 1/2.40 = 41.67% Weight of Debt = 100% = 41.67% = 58.33% WACC = 8.3% (a) Cost of Equity = 15% According to WACC Formula:

3% = 15%*41.67% + Kd*58.33% So, After-tax Cost of Debt (kd) = 3.51% Pre-tax Cost of Debt = After-tax Cost of Debt/(1-Tax Rate) = 3.51%/(1-38%) = 5.67% Therefore, pre-tax cost of debt is 5.67%. (b) After-tax Cost of Debt = 3.9% According to WACC Formula: 8.3% = Ke*41.67% + 3.9%*58.33% So, Cost of Equity (Ke) = 14.46% Therefore, cost of equity is 14.46%.

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