Question

Filer Manufacturing has 8598242 shares of common stock outstanding. The current share price is $22.72, and the book value per share is $7.24. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $58911674, has a 0.05 coupon, matures in 10 years and sells for 83 percent of par. The second issue has a face value of $53842405, has a 0.06 coupon, matures in 20 years, and sells for 92 percent of par. The most recent dividend was $1.26 and the dividend growth rate is 0.06. 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 0.36. What is Filer's WACC? Enter the answer with 4 decimals (e.g. 0.2345)

Answer 1

WACC = (weight of debt * cost of debt) + (weight of equity * cost of equity)

value of first bond issue = (face value * percent of par) = $58,911,674 * 83% = $48,896,689.42

value of second bond issue = (face value * percent of par) = $53,842,405 * 92% = $49,535,012.60

total value of debt =  $48,896,689.42 + $49,535,012.60 = $98,431,702.02

total value of equity = current share price * number of shares outstanding = $22.72 * 8,598,242 = $195,352,058.24

total value of firm = total value of debt + total value of equity =  $98,431,702.02 + $195,352,058.24 = $293,783,760.26

weight of debt =  total value of debt / total value of firm = $98,431,702.02 / $293,783,760.26 = 0.335

weight of equity = total value of equity / total value of firm =  $195,352,058.24 / $293,783,760.26 = 0.665

after tax cost of first bond issue = YTM of bonds * (1 - tax rate)

YTM is calculated using RATE function in Excel with these inputs :

nper = 10*2 (10 years to maturity with 2 semiannual coupon payments each year)

pmt = 58911674 * 0.05 / 2 (semiannual coupon payment = face value * annual coupon rate / 2. This is a positive figure as it is an inflow to the bondholder)

pv = -48896689.42 (market value of bonds. This is a negative figure as it is an outflow to the buyer of the bond)

fv = 58911674 (face value of the bond receivable on maturity. This is a positive figure as it is an inflow to the bondholder)

the RATE is calculated to be 3.72%. This is the semiannual YTM. To calculate the annual YTM, we multiply by 2. Annual YTM is 7.44%

after tax cost of first bond issue = 7.44% * (1 -0.36) = 4.76%

after tax cost of second bond issue = YTM of bonds * (1 - tax rate)

YTM is calculated using RATE function in Excel with these inputs :

nper = 20*2 (20 years to maturity with 2 semiannual coupon payments each year)

pmt = 53842405 * 0.06 / 2 (semiannual coupon payment = face value * annual coupon rate / 2. This is a positive figure as it is an inflow to the bondholder)

pv = -49535012.60 (market value of bonds. This is a negative figure as it is an outflow to the buyer of the bond)

fv = 53842405 (face value of the bond receivable on maturity. This is a positive figure as it is an inflow to the bondholder)

the RATE is calculated to be 3.43%. This is the semiannual YTM. To calculate the annual YTM, we multiply by 2. Annual YTM is 6.85%

after tax cost of second bond issue = 6.85% * (1 -0.36) = 4.38%

overall cost of debt = (after tax cost of first bond issue * (value of first bond issue / total value of debt)) + (after tax cost of second bond issue * (value of second bond issue / total value of debt))

overall cost of debt = (4.76% * ($48,896,689.42 / $98,431,702.02)) + (4.38% * ($49,535,012.60 / $98,431,702.02)) = 4.57%

cost of equity = (next year dividend / current share price) + growth rate

next year dividend = current dividend * (1 + growth rate) = $1.26 * (1 + 0.06) = $1.3356

cost of equity = ($1.3356 / $22.72) + 0.06 = 11.88%

WACC = (weight of debt * cost of debt) + (weight of equity * cost of equity)

WACC = (0.335 * 4.57%) + (0.665 * 11.88%) = 9.4304%