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Starset, Inc., has a target debt-equity ratio of 0.77. Its WACC is 11 percent, and the tax rate is 35 percent. If the company

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Answer #1

Debt-equity ratio=debt/equity

Hence debt=0.77equity

Let equity be $x

Hence debt=0.77x

Total=1.77x

WACC=Respective costs*Respective weight

a.

11=(x/1.77x*16)+(0.77x/1.77x*Cost of debt)

11=9.03954802+(0.77/1.77*Cost of debt)

cost of debt=(11-9.03954802)*1.77/0.77

=4.50649351%

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

4.50649351/(1-0.35)

=6.93%(Approx).

b.

11=(0.77x/1.77x*6)+(x/1.77x*Cost of equity)

11=2.61016949+(x/1.77x*Cost of equity)

Cost of equity=(11-2.61016949)*1.77

=14.85%

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