[shrncly]

Here is the problem. How do I go about calculating the after-tax cost of new debt and common equity. Calculate the cost of equity and calculate weighted cost of capital. I am really confused on this.

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. (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.

[CliffARobinson]

The following are steps to determine after-tax cost of new debt:

After Tax Cost of New Debt Calculation
1. Identify the company's published Corporate Tax Rate.
2. Determine the company's current Credit Rating.
3. Find the yield on 10-year Corporate Bonds with the same Credit Rating. (interest rate estimate for new debt).
4. Subtract the Interest Rate Estimate from the Company's Corporate Tax Rate from 1.
5. Multiply the result in 4 with the interest rate estimate in 3, this will give you the after tax cost of debt.