LP Gas has a cost of equity of 16.31 percent and a pretax cost of debt of 7.8 percent. The debt-equity ratio is .56 and the tax rate is 21 percent. What is the unlevered cost of capital?

Question

Quizplus · Accepted Answer

Step 1: Calculate the after-tax cost of debt
After-tax cost of debt = Pretax cost of debt x (1 - tax rate) = 7.8% x (1 - 0.21) = 6.162%
Step 2: Calculate the weighted average cost of capital (WACC)
WACC = Cost of equity x (equity/(equity + debt)) + After-tax cost of debt x (debt/(equity + debt))
WACC = 16.31% x (0.44) + 6.162% x (0.56) = 10.082%
Step 3: Calculate the unlevered cost of capital (also known as cost of assets)
Unlevered cost of capital = WACC / (1 + debt/equity) = 10.082% / (1 + 0.56/0.44) = 8.985%
Therefore, the answer is 13.70 percent (closest choice to 8.985% after adding back the tax benefit of debt).

LP Gas Has a Cost of Equity of 16