Pearson motors has a target capital structure of 30% debt and 70% common equity, with no preferred stock.

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 out standing bonds is 9%, and its tax rate is 40%. Pearsons CFO estimates that the company’s WACC is 10.50%. What is Pearson’s cost of common equity?

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Expert Solution

Wd = Weight of Debt = 30%

We = Weight of Common equity = 70%

rd = Yeild to maturity = 9%

t = tax rate = 40%

Let re = Cost of common equity

WACC = 10.50%

Cist of common equity 're' can be calculated using the below formula

WACC = [Wd * rd * (1-t)] + [We * re]

10.5% = [30% * 9% * (1-40%)] + [70% * re]

[70% * re] = 10.5% - 1.62%

70% * re = 8.88%

re = 12.68571429%

re = 12.69%

Therefore, Pearson’s cost of common equity is 12.69%

jeff jeffy answered 1 year ago

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