Question

CENGAGE MINDIAP Q Search this cours Ch 10: End-of-Chapter Problems - The Cost of Capital < Back to Assignment Attempts: 0 Keep the Highest: 0/1 3. Problem 10.03 Click here to read the eBook: The Cost of Retained Earnings, is COST OF COMMON EQUITY 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 12%, and its tax rate is 40%. Pearson's CFO estimates that the company's WACC is 19.70%. What is Pearson's cost of common equity. Do not round Intermediate calculations. Round your answer to two decimal places. Grade It Now Save & Continue Continue without saving

Answer 1

After tax cost of debts = Yield to maturity * (1 - tax rate)
= 12% * (1 - 0.40)
= 7.2%
Weighted cost of debt = 0.072 * 0.45 = 0.0324
WACC = 0.1370
Weighted cost of equity =WACC - Weighted cost of debt
= 0.1370 - 0.0324 = 0.1046

Cost of equity = Weighted cost of equity / weight
= 0.1046 / 0.55
= 0.19018 or 19.02%

Pearson's cost of common equity = 19.02%