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    Weighted average cost of capital

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    The following tabulation gives earnings per share figures for the Foust Company during the preceding 10 years. The firm's common stock, 7.8 million shares outstanding, is now (1/1/03) 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 YEAR EPS
    1993 $3.90 1998 $5.73
    1994 4.21 1999 6.19
    1995 4.55 2000 6.68
    1996 4.91 2001 7.22
    1997 5.31 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 Foust's after-tax cost of new debt and common equity. Calculate the cost of equity as ks _ D1/P0 _ g.

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

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    Solution Preview

    The following tabulation gives earnings per share figures for the Foust Company during the preceding 10 years. The firm's common stock, 7.8 million shares outstanding, is now (1/1/03) selling for $65 per share, and the expected dividend at the end of the ...

    Solution Summary

    This explains the computation of Weighted average cost of capital by taking an example

    $2.19

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