Question

Kountry Kitchen has a cost of equity of 10.8 percent, a pretax cost of debt of 6.3 percent, and the tax rate is 35 percent. If the company's WACC is 9.01 percent, what is its debt–equity ratio?

2.75

.36

1.33

.27

.49

Western Electric has 26,500 shares of common stock outstanding at a price per share of $68 and a rate of return of 13.55 percent. The firm has 6,750 shares of 6.70 percent preferred stock outstanding at a price of $89.50 per share. The preferred stock has a par value of $100. The outstanding debt has a total face value of $371,000 and currently sells for 105.5 percent of face. The yield to maturity on the debt is 7.75 percent. What is the firm's weighted average cost of capital if the tax rate is 39 percent?

10.20%

11.01%

10.63%

10.43%

11.43%

Answer 1

Answer 1
let us assume weight of debt be x and weight of equity be 1-x
After tax cost of debt = pretax cost of debt * (1-Tax rate) = 6.3% * (1-0.35) = 4.095%
WACC = [Cost of equity * Weight of equity] + [Cost of debt * Weight of debt]
9.01% = [10.8% * (1-x)] + [4.095% * x]
9.01% = 10.8% - 10.8%x + 4.095%x
9.01% = 10.8% - 6.705%x
1.79% = 6.705%x
x = 0.27
Weight of debt = 0.27
Weight of equity = 1 - 0.27 = 0.73
Debt equity ratio = debt / equity = 0.27 / 0.73 = 0.36
Answer 2
Calculation of weighted average cost of capital
Source of capital	Market value	Market weights	Cost %
A	B	C	D	C * D
Common stock	1,802,000.00	0.64	13.55%	0.0873
Preferred stock	604,125.00	0.22	6.70%	0.0145
Debt	391,405.00	0.14	4.73%	0.0066
WACC				0.1084
WACC =	10.84%
After tax cost of debt = pretax cost of debt * (1-Tax rate) = 7.75% * (1-0.39) = 4.7275%