Question

Bermuda Cruises issues only common stocks and coupon bonds. The firm has a debt-equity ratio of 0.45. The cost of equity is 17.6 percent. Required: What is the pre-tax cost of the company debt if weighted average costs of the company is 13.5% and the firm's tax rate is 35 percent? (10 marks)

Answer 1

The pre-tax cost of the company debt is 6.75%

Step-by-step explanation:

In order to calculate the pre-tax cost of the company debt if weighted average costs of the company is 13.5% and the firm's tax rate is 35 we would have to use the following formula:

weighted average cost of capital = pretax cost of debt (1 - tax rate) x weight of debt + cost of equity x weight of equity

0.135 = pretax cost of debt (1 - 0.35) x 0.45 / 1.45 + 0.176 x 1 / 1.45

0.135 = pretax cost of debt x 0.201724138 + 0.12137931

(0.135 - 0.12137931) / 0.201724138 = pretax cost of debt

6.75% Approximately = Pretax cost of debt