WACC Estimation: The following tabulation gives earnings per share figures for P
ID: 2785562 • Letter: W
Question
WACC Estimation: The following tabulation gives earnings per share figures for Pappas Manufacturing during the preceding 10 years. The firm’s common stock, 140,000 shares outstanding, is now selling for $50 a share, and the expected dividend for the coming year (2007) is 50 percent of EPS for the year. Investors expect past trends to continue, so g may be based on the historical earnings growth rate.
YEAR EPS
1997 $ 2.00
1998 2.16
1999 2.33
2000 2.52
2001 2.72
2002 2.94
2003 3.18
2004 3.43
2005 3.70
2006 4.00
The current interest rate on new debt is 8 percent. The firm’s marginal federal-plus-state-tax rate is 40 percent. The firm’s market value capital structure, considered to be optimal, is as follows: Debt $ 3,000,000 Common equity 7,000,000 Total capital $10,000,000 a. Calculate the firm’s after-tax cost of new debt and of common equity, assuming new equity comes only from retained earnings. Calculate the cost of equity assuming constant growth: that is, rS = D1/P0 + g = rS. b. Find the firm’s WACC, assuming no common stock is sold.
Explanation / Answer
a) After tax cost of debt = Interest rate(1-tax rate)
=8%(1-0.4)
=8%(0.6)
=4.8%
b) Statement showing cost of equity
Dividend for 2007 = 4.3*50% = 2.15 Rs
Cost of equity = D1/Po +g
=2.15/50 + 0.075
=0.043+0.075
=11.8%
Statement showing Cost of capital
WACC = 6.9%
Year EPS Growth(%) Comment 1997 2 1998 2.16 7.4% 1999 2.33 7.3% 2000 2.52 7.5% 2001 2.72 7.4% 2002 2.94 7.5% 2003 3.18 7.5% 2004 3.43 7.3% 2005 3.7 7.3% 2006 4 7.5% 2007 4.3 (4+7.5%)Related Questions
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