The following table gives Foust Company\'s earnings per share for the last 10 ye

Question

The following table gives Foust Company's earnings per share for the last 10 years. The common stock, 7.2 million shares outstanding, is now (1/1/15) selling for $74 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.) The current interest rate on new debt is 11%; Foust's marginal tax rate is 40%; and its target capital structure is 50% debt and 50% 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 r_s = D_1/P_0 + g. Round your answer to two decimal places. % Find Foust's WACC. Round your answer to two decimal places. %

Explanation / Answer

a) After-tax cost of debt = Cost of debt x (1-tax rate) = 11% x 0.6 = 6.6%

Cost of common equity = Ke
Price of Stock = D1 / Ke – G

D1 = EPS x Dividend Payout Ratio => $7.80 x 0.45 = $3.51

Growth Rate = [($7.80 - $7.22)/$7.22] = 8%
(You can calculate entire data on excel by given way and all will result in 8%)

Cost of common equity:
$74 = $3.51 / (Ke – 0.08)
$74Ke = $3.51 + $5.92
Ke = 12.74%

b) WACC = (Weight of debt x cost of debt) + (Weight of equity x cost of equity)
= (50% x 6.6%) + (50% x 12.74%) = 9.67%

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