Question

Tix Corp. is a grocery store located in the Southwest. It paid an annual dividend of ​$2.00 last year to its shareholders and plans to increase the dividend annually at the rate of 3.0​%. It currently has 1,000,000 common shares outstanding. The shares currently sell for ​$13 each. Four years ago, Tix Corp. issued 40,000 semiannual 22-year bonds with a coupon rate of 7​% and a par value of ​$1,000. The bonds currently have a yield to maturity​ (YTM) of 6%. What is the weighted average cost of capital (WACC) for Tix Corp. if the corporate tax rate is 30%?

When answering this problem enter your answer using percentage notation but do not use the % symbol and use two decimals (rounding). For example, if your answer is 0.10469 then enter 10.47; if your answer is 10% then enter 10.00

Answer 1

Calculation of WACC:

Given,

Dividend (D0) = 2

D1 = D0*(1+g)

= 2*(1+0.03)

= 2*1.03

= 2.06

Growth rate (g) = 3%

Price (P0) = 13

Required rate of return (ke) = ?

P0 = D1/ke-g

13 = 2.06/ke-3%

ke-3% = 2.06/13

ke = 15.85%+3%

ke = 18.85%

Market value of equity = No.of shares*Market price

= 1,000,000*13

= 13,000,000

Calculation of market price of bond:

Particulars	Years	Cash flows (1)	Discount rate @3% (2)	Discounted Cash flows (3) (1*2)
Interest	1-44	70/2 =35	24.2542	848.897
Face value	44	1000	0.2724	272.40
			Market price of bond	1121.297

Market value of bond = No.of bonds*Market price

= 40,000*1121.297

= 44,851,880

Total value = Market value of equity+Market value of bond

= 13,000,000+44,851,880

= 57,851,880

Probability of equity = Market value of equity/Total value = 13,000,000/57,851,880

= 0.22

Probability of bond = Market value of bond/Total value

= 44,851,880/57,851,880

= 0.78

Cost of debt:

After tax cost of debt = Cost of debt -tax

= 7%-7%*30%

= 7%-2.1%

= 4.9%

Calculation of WACC:

Particulars	Probability (1)	Cost (2)	WACC (3) (1*2)
Equity	0.22	18.85%	4.147%
Debt	0.78	4.9%	3.822%
		WACC	7.967%

WACC = 7.97 (rounded )