Question

The following table gives Foust Company's earnings per share for the last 10 years. The common stock, 8.2 million shares outstanding, is now (1/1/20) selling for $74.00 per share. The expected dividend at the end of the current year (12/31/20) is 45% of the 2019 EPS. Because investors expect past trends to continue, a 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 2016 6.19 2011 2012 4.21 4.55 2017 6.68 2013 4.91 2018 7.22 2014 5.31 2019 7.80 The current interest rate on new debt is 12%; Foust's marginal tax rate is 25%; and its target capital structure is 45% debt and 55% equity. a. 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 I = D./Po + g. Do not round intermediate calculations. Round your answer to two decimal places. b. Find Foust's WACC. Do not round intermediate calculations. Round your answer to two decimal places,

Answer 1

Solution:-

(a)

Cost of debt= Interest rate*(1-tax rate)= 12%*(1-25%)= 9%

Cost of equity= (D1/Po) + g

Lets calculate growth rate using the CAGR formula. 2010 EPS of $3.9 doubled in 9 years to $7.8 in 2019. The CAGR of EPS for the 9 years is as follows:

Future value= Present value*(1+r)n

7.8= 3.9*(1+r)9

r= 2^(1/9) - 1= 8%

Therefore, growth rate has been 8% based on historical CAGR.

Further, we know the following:

D1= EPS 2019*45% = $7.8*45%= $3.51

Po= $74

Therefore,

cost of equity= (3.51/74) + 8% = 12.74%

(b)

WACC= (Cost of equity*weightage of equity) + (Cost of debt*weightage of debt)

WACC= (12.74%*55%) + (9%*45%) = 11.06%