Can anyone help me witht his I am so lost.
The following tabulation gives earnings per share figures for the Foust Company during the
preceding 10 years. The firm’s common stock, 7.8 million shares outstanding, is now (1/1/03)
selling for $65 per share, and the expected dividend at the end of the current year (2003) is
55 percent of the 2002 EPS. Because investors expect past trends to continue, g may be based
on the earnings growth rate. (Note that 9 years of growth are reflected in the data.)
YEAR EPS YEAR EPS
1993 $3.90 1998 $5.73
1994 4.21 1999 6.19
1995 4.55 2000 6.68
1996 4.91 2001 7.22
1997 5.31 2002 7.80
The current interest rate on new debt is 9 percent. The firm’s marginal tax rate is 40 percent.
Its capital structure, considered to be optimal, is as follows:
Debt $104,000,000
Common equity 156,000,000
Total liabilities and equity $260,000,000
a. Calculate Foust’s after-tax cost of new debt and common equity. Calculate the cost of equity
as ks � D1/P0 � g.
b. Find Foust’s weighted average cost of capital.
a)
AT cost of debt = 0.09(1-0.4) = 5.4%
D1 = 0.55 * 7.8 = 4.29
3.9(1+g)^9 = 7.8
g = 0.08
Cost of common equity = 4.29/65 + 0.08
= 14.6%
b) WACC = (104/260)(0.054) + (156/260)(0.146) = 10.92%
To calculate Foust Company's after-tax cost of new debt and common equity, we need to follow these steps:
a. After-tax cost of new debt:
1. Identify the current interest rate on new debt, which is given as 9 percent.
2. Multiply the interest rate by (1 - tax rate) to calculate the after-tax cost. The tax rate is given as 40 percent.
After-tax cost of new debt = 9% * (1 - 0.4) = 9% * 0.6 = 5.4%
b. Cost of common equity (ks):
1. Determine the dividend expected at the end of the current year (2003). It is mentioned that the expected dividend is 55 percent of the 2002 EPS.
2. Calculate the growth rate (g) based on past trends. The growth rate is usually calculated using the compound annual growth rate (CAGR) formula, but in this case, since the data reflects 9 years of growth, we can take the growth rate as the percentage difference between the final year (2002) and the initial year (1993) divided by the number of years (9).
g = (EPS2002 - EPS1993) / 9 = (7.8 - 3.9) / 9 = 0.433
Cost of common equity (ks) = D1 / P0 - g
where D1 is the expected dividend at the end of the current year and P0 is the current stock price.
Now, to find D1, we need to calculate the 2002 EPS and then determine 55 percent of it.
2002 EPS = $7.80
D1 = 55% * 2002 EPS = 55% * $7.80 = $4.29
So, the Cost of common equity (ks) = $4.29 / $65 - 0.433 = 0.0658 - 0.433 = 0.0658 - 0.433 = 0.3688
To calculate Foust Company's weighted average cost of capital (WACC), we need to consider both the cost of new debt and the cost of common equity, weighted by their respective proportions in the capital structure.
WACC = (Weight of Debt * Cost of Debt) + (Weight of Equity * Cost of Equity)
Given the capital structure:
Debt = $104,000,000
Common equity = $156,000,000
Total liabilities and equity = $260,000,000
Weight of Debt = Debt / Total liabilities and equity = $104,000,000 / $260,000,000 = 0.4
Weight of Equity = Common equity / Total liabilities and equity = $156,000,000 / $260,000,000 = 0.6
WACC = (0.4 * 5.4%) + (0.6 * 0.3688) = 2.16% + 0.2213 = 2.3813
Therefore, Foust Company's weighted average cost of capital (WACC) is 2.3813%.