Question

Fletcher Manufacturing has 7.5 million shares of common stock outstanding. The current share price is $49 and the book value per share is $4. Fletcher Manufacturing also has two bond issues outstanding. The first bond issue has a total face value of $60 million, a coupon rate of 7%, and sells for 93% of par. The second issue has a face value of $50 million, a coupon rate of 6.5%, and sells for 96.5% of par. The first issue matures in 10 years, the second in 6 years. Suppose the company's stock has a beta of 1.2. The risk-free rate is 5.2% and the market risk premium is 7%. Assume that the overall cost of debt is the weighted average implied by the two outstanding debt issues. Both bonds make semi-annual payments. The tax rate is 35%

What is the firm's market value weight of equity? (Report answer in percentage terms and round to 2 decimal places. Do not round intermediate calculations).

What is the firm's market value weight of debt? (Report answer in percentage terms and round to 2 decimal places. Do not round intermediate calculations).

What is the firm’s cost of equity? (Report answer in percentage terms and round to 2 decimal places. Do not round intermediate calculations).

What is the firm’s cost of debt? (Report answer in percentage terms and round to 2 decimal places. Do not round intermediate calculations).

What is the firm’s WACC? (Report answer in percentage terms and round to 2 decimal places. Do not round intermediate calculations. When using previous answers, use the rounded answer as it was given in the answer box).

Answer 1

Step 1:

Number of shares outstanding= 7500,000

Price of shares= $49

Hence value of shares= 7500,000*$49 = $367,500,000

(We consider the market value of shares and debt for computing weights for WACC)

Step 2:

Market value of debt= Face value*Par

= $60,000,000*93% + $50,000,000*96.5%

=$104,050,000

Total market value= Shares+ Debt

= 367,500,000 + 104,050,000

=            471,550,000

a) Weight of equity= Equity/ Total value

= 367,500,000/ 471,550,000

=77.93%

b)Weight of debt= Debt/Total value

= 104,050,000/471,550,000

=22.07%

c)Cost of equity= Risk free rate+ Beta*Market premium

= 5.2%+1.2*7%

=13.6%

d)Cost of debt is as follows

YTM of 1^st bond= =RATE(10,7%*1000,-930,1000)

=8.05%

YTM of second bond= =RATE(6,6.5%*1000,-965,1000)

=7.24%

Cost of debt=Weighted average of two costs

= 8.05%*60/110+ 7.24%*50/110

=7.68%

Post tax cost of debt= 7.68%*(1-0.35) = 4.99%

e) WACC = Cost of equity* weight of equity + Cost of debt* weight of debt

=13.6%*77.93%+ 4.99%*22.07%

=11.7%