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Cameron Corp. has a target capital structure of 40% debt and 60% equity. The company's tax rate is 30% and the yield to maturity on their outstanding bonds is 12%. If their weighted average cost of capital is 9.6%, what is the company's cost of common equity

Answer :

Shahzaibfarazgo

Answer:

rE = 0.104 or 10.4%

Explanation:

The WACC or weighted average cost of capital is the cost of a firm's capital structure. The capital structure can consist of one or more of the following components namely debt, preferred stock and common equity. The WACC is calculated as follows,

WACC = wD * rD * (1 - tax rate)  +  wP * rP  +  wE * rE

Where,

  • w represents the weight of each component
  • r represents the cost of each component
  • D, P and E represents debt, preferred stock and common equity
  • rD * (1 - tax rate) is the after tax cost of debt

plugging in the available values for wD, wE, tax rate, rD and WACC in the formula above, we can calculate the cost of common equity to be,

0.096  =  0.4 * 0.12 * (1 - 0.3)  +  0.6 * rE

0.096 = 0.0336 + 0.6 * rE

0.096 - 0.0336 = 0.6 * rE

0.0624 / 0.6 = rE

rE = 0.104 or 10.4%

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