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# Weighted Average Cost of Capital .

The following tabulation gives earnings per share figures for the Knerr Company during the preceding 10 years. The firm's common stock, 7.8 million shares outstanding, is now (1/1/2003) selling for \$65 per share and the expected dividend at the end of the current year (2003) is 55 percent of the 2002 EPS. Because investors expect past trends to continue, g may be based on the earnings growth rate. (Note that 9 years of growth are reflected in the data.)

YEAR EPS
1993 \$3.90
1994 \$4.21
1995 \$4.55
1996 \$4.91
1997 \$5.31
1998 \$5.73
1999 \$6.19
2000 \$6.68
2001 \$7.22
2002 \$7.80

The current interest rate on new debt is 9 percent. The firm's marginal tax rate is 40 percent. Its capital structure, considered to be optimal, is as follows:

Debt \$104,000,000
Common equity \$156,000,000
Total liabilities and equity \$260,000,000

a. Calculate Knerr's after-tax cost of new debt and common equity.
Calculate the cost of equity as ks = D1/P0 +g.

b. Find Knerr's weighted average cost of capital.

See attached file for full problem description.

#### Solution Preview

The following tabulation gives earnings per share figures for the Knerr Company during the preceding 10 years. The firm's common stock, 7.8 million shares outstanding, is now (1/1/2003) selling for \$65 per share and the expected dividend at the end of the current year (2003) is 55 percent of the 2002 EPS. Because investors expect past trends to continue, g may be based on the earnings growth rate. (Note that 9 ...

#### Solution Summary

This solution is comprised of a detailed explanation to calculate Knerr's after-tax cost of new debt and common equity, calculate the cost of equity as ks = D1/P0 +g, and find Knerr's weighted average cost of capital.

\$2.19