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, 8.0 million shares outstanding, is now (1/1/13) selling for $67 per share. The expected dividend at the end of the current year (12/31/13) is 50% of the 2012 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 30% debt and 70% equity.

Year EPS Year EPS 2003 $3.90 2008 $5.73 2004 4.21 2009 6.19 2005 4.55 2010 6.68 2006 4.91 2011 7.22 2007 5.31 2012 7.80

Explanation / Answer

The EPS has grown from 3.90 to 7.80 in 9 years ( from 1993 to 2002). Using the compound interest formula, you get

7.80=3.90*(1+r/100)^9. Solving for r gives r=8%

The expected dividend (D1) is 50% of 7.80=3.9

Cost of Common Equity = D1/Po+g = (3.9/67)+.08=13.82%

After Tax cost of debt is 8*(1-0.4)=4.8%

WACC = Proportion of debt X cost of debt + Proportion of equity X cost of equity

WACC = 0.3 X 4.8% + 0.7 X 13.82%

WACC= 11.114%

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