Question

The following table gives Foust Company's earnings per share for the last 10 years. The common stock, 7.6 million shares outstanding, is now (1/1/20) selling for $70.00 per share. The expected dividend at the end of the current year (12/31/20) is 55% of the 2019 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
2010	$3.90		2015	$5.73
2011	4.21		2016	6.19
2012	4.55		2017	6.68
2013	4.91		2018	7.22
2014	5.31		2019	7.80

a.The current interest rate on new debt is 11%; Foust's marginal tax rate is 25%; and its target capital structure is 40% debt and 60% equity.

Calculate Foust's after-tax cost of debt. Round your answer to two decimal places. %

b.Calculate Foust's cost of common equity. Calculate the cost of equity as rs = D1/P0 + g. Do not round intermediate calculations. Round your answer to two decimal places. %

c.Find Foust's WACC. D not round intermediate calculations. Round your answer to two decimal places.

Answer 1

a)	After Tax Cost of Debt = Interest Rate on new debt (1-Tax Rate)
	Where,
	Interest Rate on New Debt = 11%
	Tax Rate = 25%
	Therefore,
	After Tax Cost of Debt = Interest Rate on new debt (1-Tax Rate)
		= 11% (1-25%)
		= 11% (0.75)
		=8.25%
b)	Cost of Common Equity = (D1 / P0) + g
	Where,
	D1 = 55% of 2019 EPS
	= 55% of $7.80
	= 4.29
	P0 = Current Selling Price of Common Stock = $70
	Also please noted that, according to the given data of EPS,
	the growth rate is constant. So,
	g = EPS Growth Rate
	= (EPS in 2011 - EPS in 2010) / EPS in 2010
	= (4.21 - 3.90) / 3.90
	= 0.31 / 3.90
	= 0.08
	Now,
	Cost of Common Equity = (D1 / P0) + g
		= (4.29 / 70) + 0.08
		= 0.06 + 0.08
		= 0.14
		i.e. 14%
c)	WACC
	Particulars	Weights (Wt)	Cost	Wt x Cost
	Debt	0.40	8.25	3.30
	Common Equity	0.60	14.00	8.40
			WACC	11.70
	Therefore, WACC = 11.70%