Question

Jenkins Inc. has a target capital structure of 40% debt and 60% common equity, with no preferred stock. The YTM on the company’s bonds is 9%, and its tax rate is 40%. The company’s CFO estimates that the company’s WACC is 11.5%. What is the company’s cost of common equity?

Answer 1

Answer:

15.57%

Explanation:

The WAAC (Weighted average cost of capital) is given by:

$WAAC = M*W_d*(1-T)+E*W_E$

Where M is the rate to maturity of the company's bonds, Wd is the fraction of debt, We is the fraction of equity, T is the tax rate, and E is the rate of cost of common equity. Applying the given data:

$0.115=0.09*0.4*(1-0.4)+E*0.6\\E=0.1557\\E=15.57\%$

The company’s cost of common equity is 15.57%.