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.