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Weighted Average Cost of Capital (WACC)

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)
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)