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 8%, and its tax rate is 25%. Pearson's CFO estimates that the company's WACC is 12.50%. What is Pearson's cost of common equity

Answer 1

the cost of equity is 17.82%

Step-by-step explanation:

The computation of the cost of equity is shown below:

As we know that

WACC = weight of debt × cost of debt × (1 - tax rate) + weight of equity × cost of equity

12.50% = 0.45 × 8% × (1 - 0.25) + 0.55 × cost of equity

12.50% = 2.7% + 0.55 × cost of equity

9.8% = 0.55 × cost of equity

So, the cost of equity is 17.82%