Question

Saved Ive Problems 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.) Pretax cost of debt b. Cost of equity

Answer 1

a.	Pretax cost of debt	4.73	%
b.	Cost of equity	10.9	%

Explanation:

a.

Let the debt be $ 65 and equity be $ 100

Total capital = debt + equity = $ 65 + $ 100 = $ 165

WACC or Total cost = 8.1 % x $ 165 = 0.081 x $ 165 = $ 13.365

Cost of equity = $ 100 x 0.11 = $ 11

Cost of debt after tax = $ 13.365 - $ 11 = $ 2.365

Pretax cost of debt = $ 2.365/ (1 – tax rate)

                                 = $ 2.365/ (1 – 0.23)

                                 = $ 2.365/0.77

                                 = $ 3.07142857142857

Pretax cost of debt % = $ 3.07142857142857/$ 65

                               = 0.0472527472527473 or 4.73 %

b.

Cost of debt = $ 65 x 0.038 = $ 2.47

WACC = 8.1 % or $ 13.365

Equity = $ 13.365 - $ 2.47 = $ 10.895

Cost of equity = $ 10.895/$ 100 0r 10.90 %