The following tabulation gives earnings per share figures for the Knerr Company during the preceding 10 years

The following tabulation gives earnings per share figures for the Knerr Company during the preceding 10 years. The firm's common stock, 7.8 million shares outstanding, is now (1/1/2003) 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
1993 $3.90
1994 $4.21
1995 $4.55
1996 $4.91
1997 $5.31
1998 $5.73
1999 $6.19
2000 $6.68
2001 $7.22
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 Knerr's after-tax cost of new debt and common equity.
Calculate the cost of equity as ks = D1/P0 +g.
g. = $7.80 - $7.22 = 8.0%
$7.22

ks = D1/P0 +g where D1 is the dividend next year
ks is the cost of equity
g is the growth rate
ks = D1/P0 +g
ks = $7.80(1.08)/65 +0.08
ks = 20.96%

kd = 9%(1 - 0.40) = 5.4%

b. Find Knerr's weighted average cost of capital.

WACC = WdKd(1 - T) + WcKs where Wd is the weight of debt
Kd is the cost of debt
T is the tax rate
Wc is the weight of equity
Ks is the cost of equity

Since we are given with every details, the only variable that we need to find is Ks.

= ($104,000,000/$260,000,000) x 9%(1 - 0.40) + ($156,000,000/$260,000,000) x
20.96%
= 2.16% + 12.58%
=14.74%