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.