Question

Masterson, Inc., has 4.1 million shares of common stock outstanding. The current share price is $88.00, and the book value per share is $10.50. The company also has two bond issues outstanding. The first bond issue has a face value of $78 million, a coupon rate of 5.4 percent, and sells for 96.2 percent of par. The second issue has a face value of $50 million, a coupon rate of 6.1 percent, and sells for 105.9 percent of par. The first issue matures in 22 years, the second in 11 years. The most recent dividend was $4.19 and the dividend growth rate is 4.8 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 23 percent.

What is the company’s cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

What is the company’s aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

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What is the company’s weight of equity? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

What is the company’s weight of debt? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

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

Debt:

1^st Issue of Bonds:

Face Value = $78,000,000

Market Value = 96.20% * $78,000,000
Market Value = $75,036,000

Annual Coupon Rate = 5.40%
Semiannual Coupon Rate = 2.70%
Semiannual Coupon = 2.70% * $78,000,000
Semiannual Coupon = $2,106,000

Time to Maturity = 22 years
Semiannual Period to Maturity = 44

Let semiannual YTM be i%

$75,036,000 = $2,106,000 * PVIFA(i%, 44) + $78,000,000 * PVIF(i%, 44)

Using financial calculator:
N = 44
PV = -75036000
PMT = 2106000
FV = 78000000

I = 2.853%

Semiannual YTM = 2.853%
Annual YTM = 2 * 2.853%
Annual YTM = 5.706%

Before-tax Cost of Debt = 5.706%
After-tax Cost of Debt = 5.706% * (1 - 0.23)
After-tax Cost of Debt = 4.394%

2^nd Issue of Bonds:

Face Value = $50,000,000

Market Value = 105.90% * $50,000,000
Market Value = $52,950,000

Annual Coupon Rate = 6.10%
Semiannual Coupon Rate = 3.05%
Semiannual Coupon = 3.05% * $50,000,000
Semiannual Coupon = $1,525,000

Time to Maturity = 11 years
Semiannual Period to Maturity = 22

Let semiannual YTM be i%

$52,950,000 = $1,525,000 * PVIFA(i%, 22) + $50,000,000 * PVIF(i%, 22)

Using financial calculator:
N = 22
PV = -52950000
PMT = 1525000
FV = 50000000

I = 2.691%

Semiannual YTM = 2.691%
Annual YTM = 2 * 2.691%
Annual YTM = 5.382%

Before-tax Cost of Debt = 5.382%
After-tax Cost of Debt = 5.382% * (1 - 0.23)
After-tax Cost of Debt = 4.144%

Market Value of Debt = Market Value of 1^st Issue of Bonds + Market Value of 2^nd Issue of Bonds
Market Value of Debt = $75,036,000 + $52,950,000
Market Value of Debt = $127,986,000

Weight of 1^st Issue of Debt = $75,036,000 / $127,986,000
Weight of 1^st Issue of Debt = 0.58628

Weight of 2^nd Issue of Debt = $52,950,000 / $127,986,000
Weight of 2^nd Issue of Debt = 0.41372

Estimated After-tax Cost of Debt = 0.58628 * 4.394% + 0.41372 * 4.144%
Estimated After-tax Cost of Debt = 4.29%

Equity:

Number of shares outstanding = 4,100,000
Current Price = $88.00

Market Value of Equity = 4,100,000 * $88.00
Market Value of Equity = $360,800,000

Expected Dividend = Current Dividend * (1 + Growth Rate)
Expected Dividend = $4.19 * 1.0480
Expected Dividend = $4.39112

Cost of Equity = Expected Dividend / Current Price + Growth Rate
Cost of Equity = $4.39112 / $88.00 + 0.0480
Cost of Equity = 0.0979 or 9.79%

Market Value of Firm = Market Value of Debt + Market Value of Equity
Market Value of Firm = $127,986,000 + $360,800,000
Market Value of Firm = $488,786,000

Weight of Debt = $127,986,000 / $488,786,000
Weight of Debt = 0.2618

Weight of Equity = $360,800,000 / $488,786,000
Weight of Equity = 0.7382

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Equity * Cost of Equity
WACC = 0.2618 * 4.29% + 0.7382 * 9.79%
WACC = 8.35%