Question

Masterson, Inc., has 6 million shares of common stock outstanding. The current share price is $84, and the book value per share is $5. The company also has two bond issues outstanding. The first bond issue has a face value of $145 million, has a coupon rate of 5 percent, and sells for 95 percent of par. The second issue has a face value of $130 million, has a coupon rate of 4 percent, and sells for 107 percent of par. The first issue matures in 24 years, the second in 9 years. Suppose the most recent dividend was $5.00 and the dividend growth rate is 4.9 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 25 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=84*6000000

=504000000

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

MV of Bond1=1000*145000*0.95

=137750000

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

MV of Bond2=1000*130000*1.07

=139100000

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

=504000000+137750000+139100000

=780850000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 504000000/780850000

W(E)=0.6455

Weight of debt = MV of Bond/MV of firm

Weight of debt = 276850000/780850000

W(D)=0.3545

Cost of equity

As per DDM

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

84 = 5 * (1+0.049) / (Cost of equity - 0.049)

Cost of equity% = 11.14

Cost of debt

Bond1

K = Nx2

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

k=1

K =24x2

950 =∑ [(5*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^24x2

k=1

YTM1 = 5.3731992954

Bond2

K = Nx2

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

k=1

K =9x2

1070 =∑ [(4*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^9x2

k=1

YTM2 = 3.1

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

Firm cost of debt=5.3731992954*(137750000)/(137750000+139100000)+3.1*(137750000)/(137750000+139100000)

Firm cost of debt=4.23%

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

After tax cost of debt = 4.23*(1-0.25)

= 3.1725

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

WACC=3.17*0.3545+11.14*0.6455

WACC =8.31%