Question

13. Calculating the WACC [LO3] In Problem 12 , suppose the most recent dividend was $3.25 and the dividend growth rate is 5 percent. Assume that the overall cost of debt is the weighted average of that implied by the two outstanding debt issues. Both bonds make semiannual payments. The tax rate is 21 percent. What is the company's WACC? 14. WACC [LO3] Starset, Inc., has a target debt-equity ratio of 85. Its WACC is 9.1 percent, and the tax rate is 23 percent. A. If the company's cost of equity is 14 percent, what is its pretax cost of debt? b. If instead you know that the aftertax cost of debt is 6.5 percent, what is the cost of equity?

Answer 1

I think some figures is missing in question 13 so i unable to solve it please upload it clearly

Solution :- 14

Debt equity ratio = 0.85

Therefore debt ratio (weight) = 0.85/(1+0.85) = 0.85/1.85 = 0.46

Now equity weight = 1 - 0.46 = 0.54

a) (Ke * We ) + (Kd * Wd) = Wacc

Where kd is after tax cost of debt

(14% * 0.54) + (Kd * 0.46) = 9.1%

Kd * 0.46 = 9.1% - 7.57% = 1.53%

Now kd = 1.53%/ 0.46 = 3.33%

As it is post tax kd so pre tax kd =

= Post tax Kd /(1 - tax) = 3.33% / (1-0.23) = 4.33%

b)

(Ke * We ) + (Kd * Wd) = Wacc

Where kd is after tax cost of debt

(ke * 0.54) + (6.5%* 0.46) = 9.1%

Ke * 0.54 = 9.1% - 2.99% = 6.11%

Now ke = 6.11%/ 0.54 = 11.315%

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