Question

Bonaime, Inc., has 6.1 million shares of common stock outstanding. The current share price is $61.10, and the book value per share is $4.10. The company also has two bond issues outstanding. The first bond issue has a face value of $70.1 million, a coupon rate of 7.1 percent, and sells for 97.5 percent of par. The second issue has a face value of $35.1 million, a coupon rate of 6.6 percent, and sells for 96.5 percent of par. The first issue matures in 21 years, the second in 13 years. The most recent dividend was $2.90 and the dividend growth rate is 7 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 34 percent.

What is the company’s cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Cost of equity             %

What is the company’s aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Aftertax cost of debt             %

What is the company’s equity weight? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

Equity weight            

What is the company’s weight of debt? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

Debt weight            

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.)

WACC             %

Answer 1

a)

Cost of equity = ( D1 / stock price) + growth rate

Cost of equity = [ 2.9 (1 + 0.07) / 61.1] + 0.07

Cost of equity = 0.050786 + 0.07

Cost of equity = 0.120786 or 12.08%

b)

Market value of 1st issue = 97.5% of 70,100,000 = 68,347,500

coupon rate = 7.1% of 70,100,000 = 4,977,100

Number of periods = 21 years

YTM = ?

Using a financial calculatore, YTM of 1st issue = 7.337%

Keys to use in a financial calculator: FV = 70,100,000 PV = -68,347,500, N = 21, PMT = 4,977,100, CPT I/Y)

Market value of 2nd issue = 96.5% of 35,100,000 = 33,871,500

coupon rate = 6.6% of 35,100,000 = 2,316,600

Number of periods = 13 years

YTM = ?

Using a financial calculatore, YTM of 1st issue = 7.019235%

Keys to use in a financial calculator: FV = 35,100,000 PV = -33,871,500, N = 13, PMT = 2,316,600, CPT I/Y)

Total market value of bonds = 68,347,500 + 33,871,500 = $102,219,000

Weight of 1st issue = 68,347,500 / 102,219,000 = 0.66863

Weight of 2nd issue = 33,871,500 / 102,219,000 = 0.33136

1st issue = Weight of 1st issue * YTM of first issue

1st issue = 0.66863 * 0.07337 = 0.049057

2nd issue = 0.33136 * 0.07019237 = 0.023259

Before tax cost of debt = 0.049057 + 0.023259 = 0.072316

After tax cost of debt = Before tax cost of debt ( 1 - tax)

After tax cost of debt = 0.072316 ( 1 - 0.34)

After tax cost of debt = 0.047729 or 4.78%

c)

Market value of equity = 6,100,000 * 61.1 = $372,710,000

Market value of debt = $102,219,000

Total market value = 372,710,000 + 102,219,000 = 474,929,000

Market value of equity = 372,710,000 / 474,929,000

Weight of equity = 0.7847

d)

Weight of debt = 102,219,000 / 474,929,000

Weight of debt = 0.2152

e)

WACC = Weight of equity * cost of equity + weight of debt * cost of debt

WACC = 0.7847 * 0.120786 + 0.2152 * 0.047729

WACC = 0.094781 + 0.010271

WACC = 0.105052 or 10.51%