Question

Dinklage Corp. has 4 million shares of common stock outstanding. The current share price is $83, and the book value per share is $8. The company also has two bond issues outstanding. The first bond issue has a face value of $90 million, a coupon rate of 6 percent, and sells for 98 percent of par. The second issue has a face value of $60 million, a coupon rate of 7 percent, and sells for 106 percent of par. The first issue matures in 21 years, the second in 3 years.

Suppose the most recent dividend was $5.50 and the dividend growth rate is 5 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 35 percent. What is the company’s WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

  

WACC

%

Answer 1

Number of share outstanding = 4 million

Share price = $83

Market value of equity = 4 × $83

= $332 million.

Market value of equity is $332 million.

Market value of first bond 1 = $90 × 98%

= $88.20 million.

Market value of bond 2 = $60 × 106%

= $63.60 million.

Market value of total debt = $88.20 + $63.60

= $151.80 million.

Weight of debt 1 = $88.20 / $151.80

= 58.10%

Weight of debt 2 = $63.60 / $151.80

= 41.90%

Before tax cost of debt 1 is calculated in excel and screen shot provided below:

Before tax cost of debt 1 is 6.17%.

Before tax cost of debt 2 is calculated in excel and screen shot provided below:

Before tax cost of debt 2 is 4.83%.

Weightage average before tax cost of debt = (58.10% × 6.17%) + (41.90% × 4.83%)

= 3.59% + 2.02%

= 5.61%

Weightage average before tax cost of debt is 5.61%.

Tax rate = 35%

after tax cost of debt = 5.61% × (1 - 35%)

= 3.65%

After tax cost of debt is 3.65%.

Cost of equity = [$5.50 × (1 + 5%) / $83] + 5%

= ($5.775 / $83) + 5%

= 6.96% + 5%

= 11.96%

Cost of equity is 11.96%.

Market value of total capital = $332 + $151.80

= $483.80 million.

Weight of debt = $151.80 / $483.80

= 31.38%

Weight of equity = $332 / $483.80

= 68.62%

Now, WACC is calculated below:

WACC = (31.38% × 3.65%) + (68.62% × 11.96%)

= 1.14% + 8.21%

= 9.35%

WACC of company is 9.35%.