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 14.80%. What is Pearson's cost of common equity?

Answer 1

ke=0.1922

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 14.8%

`0.148=0.65*ke+0.35*0.11(1-0.4)`

`ke=(0.148-[0.35*0.11(1-0.4)])/(0.65)`=0.192154