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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?

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bridgittaruvinga

Answer:

ke=0.1922

Explanation:

[tex]WACC=We*ke+Wd*kd(1-t)[/tex]

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%

[tex]0.148=0.65*ke+0.35*0.11(1-0.4)[/tex]

[tex]ke=\frac{0.148-[0.35*0.11(1-0.4)]}{0.65}[/tex]=0.192154

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