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Texas Instruments has 500,000 shares of common stock outstanding at a market price of $54 a...

Texas Instruments has 500,000 shares of common stock outstanding at a market price of $54 a share. Last month, Texas Instruments paid an annual dividend in the amount of $2.80 per share. The dividend growth rate is 5%. Texas Instruments also has 20,000 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 5% coupon, pay interest annually, and mature in 15 years. The bonds are selling at 104% of face value. The company's tax rate is 25%. What is Texas Instruments' weighted average cost of capital?

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Expert Solution

Debt:

Number of bonds outstanding = 20,000
Face Value = $1,000

Current Price = 104% * $1,000
Current Price = $1,040

Market Value of Debt = 20,000 * $1,040
Market Value of Debt = $20,800,000

Annual Coupon Rate = 5.00%
Annual Coupon = 5.00% * $1,000
Annual Coupon = $50

Time to Maturity = 15 years

Let Annual YTM be i%

$1,040 = $50 * PVIFA(i%, 15) + $1,000 * PVIF(i%, 15)

Using financial calculator:
N = 15
PV = -1040
PMT = 50
FV = 1000

I = 4.624%

Annual YTM = 4.624%

Before-tax Cost of Debt = 4.624%
After-tax Cost of Debt = 4.624% * (1 - 0.25)
After-tax Cost of Debt = 3.468%

Common Stock:

Number of shares outstanding = 500,000
Current Price = $54

Market Value of Common Stock = 500,000 * $54
Market Value of Common Stock = $27,000,000

Expected Dividend = Current Dividend * (1 + Growth Rate)
Expected Dividend = $2.80 * 1.05
Expected Dividend = $2.94

Cost of Common Stock = Expected Dividend / Current Price + Growth Rate
Cost of Common Stock = $2.94 / $54.00 + 6.000%
Cost of Common Stock = 5.444% + 6.000%
Cost of Common Stock = 11.444%

Market Value of Firm = Market Value of Debt + Market Value of Common Stock
Market Value of Firm = $20,800,000 + $27,000,000
Market Value of Firm = $47,800,000

Weight of Debt = $20,800,000 / $47,800,000
Weight of Debt = 0.43515

Weight of Common Stock = $27,000,000 / $47,800,000
Weight of Common Stock = 0.56485

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Common Stock * Cost of Common Stock
WACC = 0.43515 * 3.468% + 0.56485 * 11.444%
WACC = 7.97%

jeff jeffy answered 1 year ago
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