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 12%, and its tax rate is 25%. Pearson's CFO estimates that the company's WACC is 10.70%. What is Pearson's cost of common equity? Do not round intermediate calculations. Round your answer to two decimal places. Hide Feedback Incorrect
Cost of Debt, Cost of Preferred Stock
This article deals with the estimation of the value of capital and its components. we'll find out how to estimate the value of debt, the value of preferred shares , and therefore the cost of common shares . we will also determine the way to compute the load of every cost of the capital component then they're going to estimate the general cost of capital. The cost of capital refers to the return rate that an organization gives to its investors. If an organization doesn’t provide enough return, economic process will decrease the costs of their stock and bonds to revive the balance. A firm’s long-run and short-run financial decisions are linked to every other by the assistance of the firm’s cost of capital.
Cost of Common Stock
Common stock is a type of security/instrument issued to Equity shareholders of the Company. These are commonly known as equity shares in India. It is also called ‘Common equity
![**Transcription for Educational Website**
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**Topic: Finance - Cost of Common Equity Calculation**
**Question:**
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 12%, and its tax rate is 25%. Pearson’s CFO estimates that the company’s WACC is 10.70%. What is Pearson’s cost of common equity?
**Instructions:**
Do not round intermediate calculations. Round your answer to two decimal places.
**Feedback:**
*Incorrect*
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**Explanation:**
To find the cost of common equity, we use the formula for the weighted average cost of capital (WACC):
\[ \text{WACC} = (E/V) \times Re + (D/V) \times Rd \times (1 - Tc) \]
Where:
- E = Market value of equity
- V = Total market value of equity and debt
- Re = Cost of equity
- D = Market value of debt
- Rd = Cost of debt (yield to maturity on bonds)
- Tc = Corporate tax rate
Given values:
- E/V = 65% or 0.65
- D/V = 35% or 0.35
- Rd = 12% or 0.12
- Tc = 25% or 0.25
- WACC = 10.70% or 0.107
Plug these into the formula and solve for Re:
\[ 0.107 = 0.65 \times Re + 0.35 \times 0.12 \times (1 - 0.25) \]
Calculate the components, solve the equation, and ensure the answer is rounded to two decimal places.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F9336b0a8-199d-485e-9442-5d0fe1f82213%2Fc17d247c-6b12-4bc6-82f5-97f86914104d%2Fl7u5q3_processed.jpeg&w=3840&q=75)
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