WACC The following table gives Foust Company\'s earnings per share for the last

Question

WACC

The following table gives Foust Company's earnings per share for the last 10 years. The common stock, 8.6 million shares outstanding, is now (1/1/15) selling for $76 per share. The expected dividend at the end of the current year (12/31/15) is 65% of the 2014 EPS. Because investors expect past trends to continue, g may be based on the historical earnings growth rate. (Note that 9 years of growth are reflected in the 10 years of data.)

The current interest rate on new debt is 8%; Foust's marginal tax rate is 40%; and its target capital structure is 35% debt and 65% equity.

Calculate Foust's after-tax cost of debt. Round your answer to two decimal places.
_____%

Calculate Foust's cost of common equity. Calculate the cost of equity as rs = D1/P0 + g. Round your answer to two decimal places.
_____%

Find Foust's WACC. Round your answer to two decimal places.
_____ %

Year EPS Year EPS 2005 $3.90 2010 $5.73 2006 4.21 2011 6.19 2007 4.55 2012 6.68 2008 4.91 2013 7.22 2009 5.31 2014 7.80

Explanation / Answer

Part A)

The after tax cost of debt will be calculated with the use of current interest rate and tax rate. The formula for calculating after-tax cost of debt is:

After-Tax Cost of Debt = Cost of Debt*(1-Tax Rate)

____________

Using the information provided in the question, we get,

After-Tax Cost of Debt = 8*(1-.40) = 4.80%

___________________

Part B)

To calculate cost of common equity, we need to calculate the growth rate. The growth rate can be calculated with the use of rate function in Financial Calculator/EXCEL. The formula/function for rate is Rate(Nper,PMT,-PV,FV) where Nper = Period, PMT = Payment (if any), PV = Present Value and FV = Future Value.

____________

Here, Nper = 10, PMT = 0, PV = $3.90 and FV = $7.80

Using this information in the above function, we get,

Growth Rate = Rate(10,0,-3.90,7.80) = 7.18%

____________

Cost of Equity = D1/Current Stock Price (P0) + Growth Rate = (7.80*65%)/76 + 7.18% = 13.85%

___________________

Part C)

WACC is calculated with the use of following formula:

WACC = After-Tax Cost of Debt*Weight of Debt + Cost of Equity*Weight of Equity

____________

Here, After-Tax Cost of Debt = 4.80%, Weight of Debt = 35%, Cost of Equity = 13.85% and Weight of Equity = 65%

Using these values in the above formula, we get,

WACC = 4.80%*35% + 13.85%*65% = 10.68%

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