Question

Dinklage Corp. has 5 million shares of common stock outstanding. The current share price is $71, and the book value per share is $10. The company also has two bond issues outstanding. The first bond issue has a face value of $80 million, a coupon rate of 4 percent, and sells for 96 percent of par. The second issue has a face value of $65 million, a coupon rate of 3 percent, and sells for 108 percent of par. The first issue matures in 20 years, the second in 9 years.

Suppose the most recent dividend was $4.35 and the dividend growth rate is 4.6 percent. Assume that the overall cost of debt is the weighted average of that implied by the two outstanding debt issues. Both bonds make semiannual payments. The tax rate is 22 percent. What is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

MV of equity=Price of equity*number of shares outstanding

MV of equity=71*5000000

=355000000

MV of Bond1=Par value*bonds outstanding*%age of par

MV of Bond1=1000*80000*0.96

=76800000

MV of Bond2=Par value*bonds outstanding*%age of par

MV of Bond2=1000*65000*1.08

=70200000

MV of firm = MV of Equity + MV of Bond1+ MV of Bond 2

=355000000+76800000+70200000

=502000000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 355000000/502000000

W(E)=0.7072

Weight of debt = MV of Bond/MV of firm

Weight of debt = 147000000/502000000

W(D)=0.2928

Cost of equity

As per DDM

Price = recent dividend* (1 + growth rate )/(cost of equity - growth rate)

71 = 4.35 * (1+0.046) / (Cost of equity - 0.046)

Cost of equity% = 11.01

Cost of debt

Bond1

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =20x2

960 =∑ [(4*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^20x2

k=1

YTM1 = 4.3001988999

Bond2

K = Nx2

Bond Price   =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =9x2

1080 =∑ [(3*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^9x2

k=1

YTM2 = 2.02

Firm cost of debt=YTM1*(MV bond1)/(MV bond1+MV bond2)+YTM2*(MV bond2)/(MV bond1+MV bond2)

Firm cost of debt=4.3001988999*(76800000)/(76800000+70200000)+2.02*(76800000)/(76800000+70200000)

Firm cost of debt=3.21%

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 3.21*(1-0.22)

= 2.5038

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=2.5*0.2928+11.01*0.7072

WACC =8.52%