Question

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 outstanding bonds is 12%, 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? Do not round intermediate calculations. Round your answer to two decimal places.

Answer 1

Answer: 14%

Explanation: The average rate expected by all of the security holders of a company in return of investing in it is called WACC.

formula to compute WACC :-

$WACC= \left ( weight\:of\:debt\times cost\:of\:debt \right )+\:\left ( weight\:of\:equity\times cost\:of\:equity \right )$

$12.5\%= \left ( 30\%\times 9\% )+\:\left ( 70\%\times cost\:of\:equity \right )$

so,

cost of equity = 14 %

Answer 2

Answer:

The total amount of all common equity investors' investments in a firm, along with the total value of all common shares, plus retained earnings (RE) and additional paid-in capital (APIC), is known as common equity.

Explanation:

The stock of a company is neither an asset nor a liability. A common stock is a type of investment.

• The cost of common equity at Pearson is 14%.
• Given:
• WACC =12.50%
• Tax rate = 25%
• Outstanding bibds = 12%
• Capital structure = 30:70

$\text{After-tax cost of debt}$ $= \text{yield to maturity}$ × $(1-\text{tax rate})$

$= 12(1-0.25)$

$=9$%

$\text{WACC} =$ $\text{Respective costs}$ × $\text{Respective weight}$

$12.5 = (9) (0.3) + (0.7)$ × $\text{Cost of common equity}$

$\text{Cost of common equity}$ = $\frac{(12.5-2.7)}{0.7}$

$=14.00$%

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