Fundamentals of Financial Manageme...
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Fundamentals of Financial Manageme...
COST OF COMMON EQUITY Percy 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%. Percy’s CFO estimates that the company’s WACC is 9.96%. What is Percy’s cost of common equity?
To determine: The cost of equity of P motors.
Weighted Average Cost of Capital (WACC):
It is the weighted average cost of all the sources through which the firm finances its capital. It is that rate that company will pay to all for raising finance. It can be termed as firm’s cost of capital.
The company raises money through various sources such as common stock, preference share debt, the WACC is calculated taking the relative weight of each item of capital structure.
The formula to calculate WACC is,
Where,
Cost of Equity:
It is the cost of the company while raising finance by issuing equity. It is earnings from the investment to the firm’s equity investors. It is the return to the stockholder holders’ equity investments.
Given,
WACC is 9.96%.
Weight of debt is 40%.
Cost of debt is 9%.
Weight of equity is 60%.
Tax rate is 40%.
The company does not have any preferred stock, then the formula to calculate WACC is,
Where,
- t is the tax rate.
Substitute 9.96% for WACC, 0.40 for
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