Question

Pearson Motors has a target capital structure of 30% debt and 70% common equity, with no preferred stock. The yield to maturity on the company's outstanding bonds is 9%, and its tax rate is 25%. Pearson's CFO estimates that the company's WACC is 12.20%. What is Pearson's cost of common equity? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

The cost of common equity for Pearson Motors can be calculated using the Gordon Growth Model.

Pearson Motors' cost of common equity can be calculated using the formula:

Cost of Equity = (Dividends per Share / Current Stock Price) + Growth Rate

Since the question doesn't provide information about dividends or the growth rate, we need to use the Gordon Growth Model to estimate the cost of equity.

The Gordon Growth Model formula is: Cost of Equity = (Dividends per Share / Current Stock Price) + Growth Rate).

Assuming a constant growth rate, the formula simplifies to: Cost of Equity = Dividend Yield + Growth Rate.

Given that Pearson Motors has no preferred stock, we can assume that the cost of common equity is equal to the cost of equity.

Therefore, we can use the formula Cost of Equity = Dividend Yield + Growth Rate to calculate the cost of common equity.