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4 September, 07:39

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 10%, and its tax rate is 40%. Pearson's CFO estimates that the company's WACC is 11.50%. What is Pearson's cost of common equity? Do not round intermediate calculations. Round your answer to two decimal places.

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  1. 4 September, 08:09
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    The Pearson's cost of common equity is 16.00%

    Explanation:

    For computing the cost of common equity, following formula should be used which is shown below:

    WACC = (Equity portion * total cost of equity) + (debt portion * total cost of debt) * (1 - tax rate)

    11.50% = (0.55 * total cost of equity) + (0.45 * 0.10) * (1 - 0.40)

    11.50% = (0.55 * total cost of equity) + 0.045 * 0.60

    11.50% = (0.55 * total cost of equity) + 0.027

    11.50% - 2.70% = (0.55 * total cost of equity)

    8.80% : 0.55 = total cost of equity

    So, total cost of equity = 16.00%

    Hence, the Pearson's cost of common equity is 16.00%
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