Question

AnimalChin! is a well-established company. Because of its market share and a fairly stable revenue stream, 3 years ago they successfully issued 20-year maturity 8% bonds, paying semiannually. Today, these bonds are selling for 95% of their face value. The total face value of these bonds is $4 billion. The company also issued 7% convertible bonds, paying semiannually, trading at 104% of their face value, maturing in 20 years. The total face value of these bonds is $3 billion. Finally, they just received a $2.2 billion term loan from a bank, the bank is currently charging a 6% interest on the loan. AnimalChin is publicly-traded. Today, its common stock trades for $18 per share. There are .8 billion shares outstanding. Its preferred stock is trading at $10 and just paid a dividend of $0.8. There are .3 billion preferred shares outstanding. The five financial analysts currently covering the company expect AnimalChin to grow at a similar pace as the whole skateboarding sec-tor: about 4%. The last dividend paid on common stock was $1.8 per share. The company’s most recent es-timated beta is 1.2. The risk-free rate is 4% and the expected market risk premium 8%. For the Veloce project the company’s CFO has decided to apply an adjustment factor of 1.5% to the compa-ny’s WACC to account for additional risk.

1) Calculate Animal Chin’s cost of all debt and the after-tax cost of debt. (Show work)

2) Calculate Animal Chin’s average cost of equity. (Show work)

3) Calculate Animal Chin’s cost of preferred. (Show work)

4) Calculate the market value of debt, equity, preferred, and the company’s total market value. (Show work)

5) Calculate the WACC. (Show work)

Answer 1

1) calculation of Pre-tax Cost of debt:
Using financial calculator:
(a) 20-year maturity bond: N=(20-3)*2=34, PV=4*0.95=3.80, PMT=-0.04*4=-0.16; FV=-4; CPT---> I/Y = 4.28%. This is the half year yield. Annual YTM = 4.28*2 = 8.56%
(b) 7% convertible bonds: N=20*2=40, PV=3*1.04=3.12, PMT=-0.035*3=-0.105; FV=-3; CPT---> I/Y = 3.32%. This is the half year yield. Annual YTM = 3.32*2 = 6.64%
(c) Bank loan = 6%

Since no tax rate is provided, the above calculated rates are also considered to be after-tax cost of debts.

2)
Cost of Equity = Rf+(Beta*market risk premium) = 4+ (1.2*8) = 13.60%

3)
Cost of preferred stock: D1/P0 = 0.8/10 = 8%

4)
20-year coupon bond = 95% of $4 billion = $3.80 billion
7% convertible bond = 104% of $3 billion = $3.12 billion
bank loan = $2.2 billion
preference shares = 0.3 billion shares *$10 per share = $3 billion
equity = 0.8 billion shares * $18 per share = $14.40 billion
Total market value of company = 3.8+3.12+2.2+3+14.40 = $26.52 billion

5)

Particulars	cost of capital	Market value	Weighted average
20-year coupon bond	8.56%	3.80	1.23%
7% convertible bond	6.64%	3.12	0.78%
bank loan	6.00%	2.20	0.50%
Prefference shares	8.00%	3.00	0.90%
Equity	13.60%	14.40	7.38%
TOTAL		26.52	10.80%

WACC of the company = WACC based on capital structure + 1.50% risk premium = 10.80+1.50 = 12.30%

Let me know the tax rate, I will update the answer. In the absence of tax rate, this would be the correct answer.