Question

Clifford, Inc., has a target debt-equity ratio of .65. Its WACC is 8.1 percent, and the tax rate is 23 percent. a. If the company's cost of equity is 11 percent, what is its pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. If the aftertax cost of debt is 3.8 percent, what is the cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Skipped Pretax cost of debt b. Cost of equity

Answer 1

Debt-equity ratio=debt/equity

Hence debt=0.65*equity

Let equity be $x

Debt=$0.65x

Total=$1.65x

WACC=Respective costs*Respective weight

a.

8.1=(x/1.65x*11)+(0.65x/1.65x*Cost of debt)

8.1=6.667+(0.65/1.65*Cost of debt)

Cost of debt=(8.1-6.667)*1.65/0.65

=3.63846153%

Pre-tax Cost of debt=Cost of debt/(1-tax rate)

=3.63846153%/(1-0.23)

=4.73%(Approx).

b.

8.1=(x/1.65x*Cost of equity)+(0.65x/1.65x*3.8)

8.1=(1/1.65*Cost of equity)+1.4969697

Cost of equity=(8.1-1.4969697)*1.65

=10.90%(Approx).