Question

Dinklage Corp. has 9 million shares of common stock outstanding. The current share price is $81, and the book value per share is $7. The company also has two bond issues outstanding. The first bond issue has a face value of $130 million, a coupon rate of 6 percent, and sells for 92 percent of par. The second issue has a face value of $115 million, a coupon rate of 5 percent, and sells for 103 percent of par. The first issue matures in 24 years, the second in 10 years.

Suppose the most recent dividend was $4.85 and the dividend growth rate is 5.2 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

Solution :-

First calculate Market Values

Market value of Bond 1 = 130,000,000 x 92% = $119,600,000.00

Market value of Bond 2 = 115,000,000 x 103% = $118,450,000.00

Market value of common stock = 9,000,000 x 81 = $729,000,000.00

Total market value = $967,050,000.00

Now,

After tax cost of debt

= Before tax cost of debt x (100 - Tax Rate)

= Bond Yield to maturity x (100 - Tax Rate)

In case of semi-annual coupons,

Bond YTM

= Semi Annual YTM x 2

= (Semi Annual coupon + ((Face Value - Price) / Number of periods to maturity)) / ((Face Value + Price) / 2) x 2

Here,

For Bond 1,

Semi Annual Coupon = 1000 x 6% x 1/2 = $30.00

Face Value = $1,000.00 (Assumed)

Price = 1000 x 92% = $920.00

Number of periods to maturity = 24 x 2 = 48

So,

After tax cost of debt of Bond 1

= (30 + ((1000 - 920) / 48)) / ((1000 + 920) / 2) x 2 x ( 1- 0.22)

= 5.146%

For Bond 2,

Semi Annual Coupon = 1000 x 5% x 1/2 = $25.00

Face Value = $1,000.00 (Assumed)

Price = 1000 x 103% = $1,030.00

Number of periods to maturity = 10 x 2 = 20

So,

After tax cost of debt of Bond 2

= (25 + ((1000 - 1030) / 20)) / ((1000 + 1030) / 2) x 2 x (1-0.22)

= 3.612%

Cost of equity

= Expected dividend / Current price + Growth rate

Here,

Expected dividend = Current dividend x (1 + Growth rate) = 4.85 x 1.052 = $5.102

Current price = $81.00

Growth rate = 5.2% = 0.052

So,

Cost of equity

= 5.102 / 81 + 0.052

= 11.50%

Now,

WACC

= (5.146% x 119.6 / 967.05) + (3.612% x 118.45 / 967.05) + (11.50% x 729 / 967.05)

= 9.748%

= 9.75%