The following table gives earnings per share figures for the Brueggeman Company during the preceding 10 years. The firm's common stock, 7.8 million shares outstanding, is now (January 1, 2008) selling for $65 per share, and the expected dividend at the end of the current year (2008) is 55 percent of the EPS expected in 2008. Because investors expect past trends to continue, g can be based on the earnings growth rate. (Note that nine years of growth are reflected in the data)

The current before-tax interest rate on debt is 9 percent. The firm's marginal tax rate is 40 percent. Its capital structure, considered to be optimal, is as follows:

a. Calculate Brueggeman's after-tax cost of new debt and of common equity, assuming that new equity comes only from retained earnings. Calculate the cost of equity r_s = ₁/P₀ + g.

b. Find Brueggeman's WACC, again assuming that no new common stock is sold and that all debt costs 9 percent.

c. How much can be spent on capital investments before external equity must be sold? (Assume that retained earnings available for 2008 are 45 percent of 2008 earnings. Obtain 2008 earnings by multiplying the expected 2008 EPS by the shares outstanding.)

d. What is Brueggeman's WACC (cost of funds raised in excess of the amount calculated in part c) if new common stock can be sold to the public at $65 a share to net the firm $58.50 a share? The cost of debt is constant.

 

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