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 40%. Pearson's CFO estimates that the company's WACC is 12.80%. What is Pearson's cost of common equity

Answer 1

The company's cost of common equity is 19.3%

Step-by-step explanation:

To calculate the company's cost of common equity we have to use the formulate to calculate the WACC.

WACC = WEKE + (WDKD x (1 - T))

0.1280 = (0.55 x KE) + ((0.45 x 0.08) x (1 - 0.40))

0.1280 = 0.55KE + (0.036 x 0.60)

0.55KE = 0.1280 - 0.0216

0.55KE = 0.1064

KE = 0.1064 / 0.55

KE = 0.193 or 19.3%