The Tree House has a pretax cost of debt of 7.3 percent and a return on assets of 12.8 percent.The debt-equity ratio is .46.Ignore taxes.What is the cost of equity?
A)14.50 percent
B)14.82 percent
C)15.47 percent
D)14.98 percent
E)15.33 percent

Question

Quizplus · Accepted Answer

Using the formula 
Return on assets (ROA) = Weighted average cost of capital (WACC) 
we can find the WACC:

WACC = (cost of equity x equity weight) + (cost of debt x debt weight)

Given: 
Cost of debt = 7.3%
Debt-equity ratio = 0.46

Therefore, the equity weight is 1 - 0.46 = 0.54

Let's solve for the cost of equity:

12.8% = (cost of equity x 0.54) + (7.3% x 0.46)

12.8% = 0.54(cost of equity) + 3.358%

9.442% = 0.54(cost of equity)

cost of equity = 17.46%

Therefore, the answer is E) 15.33% (nearest hundredth).

The Tree House Has a Pretax Cost of Debt of 7.3