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, 6.7 million shares outstanding, is now (1/1/15) selling for $62 per share. The expected dividend at the end of the current year (12/31/15) is 45% 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.) 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 The current interest rate on new debt is 11%; Foust's marginal tax rate is 40%; and its target capital structure is 55% debt and 45% equity.

Explanation / Answer

We first need to compute EPS growth rate:

(1+g)^9 = (7.80/3.90)

1+g = 1.08

G = 8%

Cost of Equity = D1/ P   + g

                            = 7.80 x 0.45 / 62 + 0.08

                            = 13.66%

WACC = Kd x Wd x (1-t) + Ke x We

            = 0.11 x 0.55 x (1-0.40) + 0.1366 x 0.45

                = 0.0363 + 0.06147

                = 9.78%

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