Question

Pearson Motors has a target capital structure of 45% debt and 55% common equity, with no preferred stock. The yield to maturity on the company's outstanding bonds is 12%, and its tax rate is 25%. Pearson's CFO estimates that the company's WACC is 10.30%. What is Pearson's cost of common equity? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

Answer:

11.36%

Explanation:

According to the scenario, computation of the given data are as follows,

Debt = 45%

Common equity = 55%

YTM = 12%

Tax rate = 25%

WACC = 10.30%

So, we can calculate the cost of equity by using following formula,

WACC = Debt × YTM (1 - Tax rate) + Common Equity × Cost of Equity

By putting the value, we get

10.30% = 45% × 12% × (1 - 25%) + 55% × Cost of Equity

0.103 = 0.45 × 0.12 ( 0.75) + 0.55 × Cost of Equity

0.103 = 0.0405 + 0.55 × cost of equity

0.103 - 0.0405 = 0.55 × cost of equity

Cost of equity = 0.0625 ÷ 0.55

So, Cost of equity = 0.1136 or 11.36%