Question

Pearson Motors has a target capital structure of 35% debt and 65% common equity, with no preferred stock. The yield to maturity on the company's outstanding bonds is 11%, and its tax rate is 40%. Pearson's CFO estimates that the company's WACC is 12.90%. What is Pearson's cost of common equity? Do not round intermediate calculations. Round your answer to two decimal places. 16.29 %

Answer 1

ke=16.29

Step-by-step explanation:

`WACC=We*ke+Wd*kd(1-t)`

Where:

We=weight of common equity in the capital structure

ke=cost of equity

Wd=Weight of debt in the capital structure

kd= Cost of debt i.e yield to maturity on the bonds

t= tax rate.

Since WACC is estimated to be 12.9%

`0.129=0.65*ke+0.35*0.11(1-0.4)`

`ke=(0.129-[0.35*0.11(1-0.4)])/(0.65)`=0.162923