Debbie's Cookies has a return on assets of 8.7 percent and a cost of equity of...

Question

Question

Debbies Cookies has a return on assets of 8.7 percent and a cost of equity of 13.1 percent. What is the pretax cost of debt

Answer 1

Answer #1

In a firm, WACC should be ideally equal to return on assets.

WACC = Weight of debt * Cost of debt + Weight of equity * Cost of Equity

Debt-Equity Ratio = 0.81

Debt/Equity = 0.81

This implies if debt = 0.81, Equity =1.

Weight of debt = 0.81/(0.81 + 1) = 0.4475

Weight of equity = 1/(0.81 + 1) = 0.5525

8.7% = 0.4475 * Cost of debt + 0.5525 * 13.1%

8.7% = 0.4475 * Cost of debt + 7.24%

1.4624% = 0.4475 * Cost of debt

Cost of debt = 3.27%

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Answer 2

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