Landry Corp. is evaluating one of its recent investments and the financial aspects of their investment. The Investment Center has provided the following data: Based on the information provided above, what is the company's Cost of Debt? (Do not round intermediate calculations.)
A) 10.22%
B) 12.74%
C) 14.19%
D) 24.20%

Question

Landry Corp. is evaluating one of its recent investments and the financial aspects of their investment. The Investment Center has provided the following data:  Based on the information provided above, what is the company's Cost of Debt? (Do not round intermediate calculations.)
A) 10.22% 
B) 12.74% 
C) 14.19% 
D) 24.20%

Quizplus · Accepted Answer

This question involves multiple steps before arriving at the Cost of Debt. The first step is to use the formula for Economic Value Added (EVA) to determine the Weighted Average Cost of Capital (WACC). EVA = After-Tax Operating Income - (WACC × Investment). $33.90 = (($29,870 - $27,606) × (1 - 0.23)) - (WACC × $13,422). $33.90 = ($2,264 × 0.77) - (WACC × $13,422). $33.90 = $1,743.28 - (WACC × $13,422). -$1,709.38 = -WACC × $13,422. Next, divide each side by $13,422. -0.1274 = -WACC. Then, divide each side by -1 to find the WACC. WACC = 0.1274. Now, use the formula for WACC to calculate the Cost of Debt. WACC = (Cost of Debt × Proportion of Capital Financed with Debt) + (Cost of Equity × Proportion of Capital Financed with Equity). 0.1274 = (Cost of Debt × 0.72) + (0.09 × 0.28). 0.1274 = (Cost of Debt × 0.72) + 0.0252. 0.1022 = Cost of Debt × 0.72. Finally, divide each side by 0.72 to find the Cost of Debt. So, Cost of Debt = 0.1419 or 14.19% (Choice C).