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Weighted Average Cost of Capital (WACC)

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The following tabulation gives earnings per share figures for the Foust Company during the preceding 10 years. The firms' 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 pas trends to continue, g may be based on the earnings growth rate (Noted 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

1. Calculate Foust's after-tax cost of new debt and common equity. Calculate the cost of equity as Ks = D1/P0 + g.
2. Find Foust's weighted average cost of capital

I've figured out the after-tax cost of debt
9%(1.0 -.40)
9%(.60)
answer= 5%

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Solution Preview

a. The cost of equity is to be calculated as Ks=D1/P0+g where D1 is the expected dividend, P0 is the market price and g is the growth rate.
First find g the earnings growth rate. g is the compound annual growth rate in EPS. The EPS has grown from 3.90 to 7.80 in 9 years ( from 1993 to ...

Solution Summary

The solution explains how to calculate the Weighted Average Cost of Capital (WACC)

$2.19
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Weighted Average Cost of Capital (WACC) calculations

A company's balance sheets show a total of $30 million long-term debt with a coupon rate of 9 percent. The yield to maturity on this debt is 11.11 percent, and the debt has a total current market value of $25 million. The balance sheets also show that that the company has 10 million shares of stock; the total of common stock and retained earnings is $30 million. The current stock price is $7.5 per share. The current return required by stockholders, rS, is 12 percent. The company has a target capital structure of 40 percent debt and 60 percent equity. The tax rate is 40%. What weighted average cost of capital should you use to evaluate potential projects?

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