COST OF COMMON EQUITY Pearson Motors has a target capital st

COST OF COMMON EQUITY Pearson Motors has a target capital structure of 40% debt and 60% common equity, with no preferred stock. The yield to maturity on the company\'s outstanding bonds is 9%, and its tax rate is 40%. Pearson\'s CFO estimates that the company\'s WACC is 14.20%, what is Pearson\'s cost of common equity? Do not round intermediate calculations. Round your answer to two decimal places. 4.11 Hide Feedback Incorrect

Solution

After Tax Cost of Debt = Yield to Maturity * ( 1- Tax Rate)

= 9% * ( 1-40%)

= 5.40%

WACC = Cost of Debt * Weight of Debt + Cost of Equity * Weight of Equity

14.20% = 5.40% * 40% + Cost of Equity * 60%

or 14.20% =2.16 % + 0.6 * Cost of Equity

or 14.20% - 2.16% =  0.6 * Cost of Equity

or 12.04 % / 0.6 = Cost of Equity

Cost of Equity = 20.07%

Hence the correct answer is 20.07%