Question

Question 3

DYB Battery is a battery manufacturer producing high-quality lithium ion battery cells or electric cars. The business of DYB has been flourishing in recent years and the board of directors intends to expand the business by acquiring companies overseas. One of the acquisition targets is an electric car manufacturer in Taiwan. The management of DYB believes this car manufacturer will bring handsome revenue to the company in the future. As a business analyst of the DYB, you have been asked to determine the Weighted Average Cost of Capital (WACC) of your company. The senior management of the company would like to use DYB’s WACC to benchmark potential acquisition targets.The current capital structure information of the company is as follows: i 800,000 shares of common stock with a currently price of $50 per share ii 500,000 shares of preferred stock currently trading at $40 per share in the market. The fixed annual dividend of this preferred stock is $4.80 per share. iii 30,000 units of 10-years, 7% p.a. coupon bonds with semi-annual interest payment. The bond has exactly four years to maturity with a par value of $1,000. The current quotation of this bond is 95, which means 95% of its par value. Bonds with similar risk, interest term and maturity are currently selling at 8.50067% p.a. yield to maturity. iv An $11,500,000 long-term bullet payment loan with Open Bank. The loan was borrowed two months ago with a 9% p.a. borrowing rate. The market value of this bank loan is not available. v The expected market return is 12%, the risk-free rate is 4% and the beta of DYB’s common stock is 1.25 respectively. The marginal tax rate is 20%. Answer the following questions:

a What is the capital structure of DYB on a market value basis? Please make assumptions in your calculation if necessary.

b Evaluate the weighted average cost of capital (WACC) of the company.

c Discuss whether DYB should simply apply its WACC as the benchmark to evaluate the acquisition of the electric car manufacturer.

Answer 1