Question

Filer Manufacturing has 9,781,556 shares of common stock outstanding. The current share price is $42.39, and the book value per share is $9.09. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $58,819,081, has a 0.05 coupon, matures in 10 years and sells for 83 percent of par. The second issue has a face value of $75,900,893, has a 0.06 coupon, matures in 20 years, and sells for 92 percent of par.

The most recent dividend was $2.47 and the dividend growth rate is 0.07. 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 0.38.

What is Filer's WACC?

Answer 1

WACC = weight of debt*after-tax cost of debt + weight of common stock*cost of common stock

cost of debt is the yield to maturity of the bond. yield to maturity is the return as investor will earn if he holds the bond till maturity. Filer has 2 bonds outstanding. so there will be 2 cost of debts.

Calculation of weights:

Total market value of Filer = market value of bond 1 + market value of bond 2 + market value of common stock

market value of bond 1 = face value*current selling price as % of face value = $58,819,081*83% = $48,819,837.23

market value of bond 2 = face value*current selling price as % of face value = $75,900,893*92% = $69,828,821.56

market value of common stock = no. of shares outstanding*current price per share = 9,781,556*$42.39 = $414,640,158.84‬

Total market value of Filer = $48,819,837.23 + $69,828,821.56 + $414,640,158.84‬ = $533,288,817.63‬

weight of debt/common stock = market value of debt or common stock/Total market value of firm

weight of Bond 1 = $48,819,837.23/$533,288,817.63 = 0.09

weight of Bond 2 = $69,828,821.56/$533,288,817.63 = 0.13

weight of common stock = $414,640,158.84‬/$533,288,817.63‬ = 0.78

Cost of debt:

we can use financial calculator for calculation of yield to maturity (YTM) of the bond with below keystrokes:

Coupons are paid semi-annual. so maturity will be double and coupon will be half.

cost of bond 1

N = maturity = 10*2 = 20; PV = market value = -$48,819,837.23, FV = face value = $58,819,081; PMT = semi-annual coupon = $58,819,081*(5%/2) = $1,470,477.025‬ > CPT= Compute > I/Y = semi-annual YTM = 3.72%

PV needs to entered as negative value because it's a cash outflow.

This YTM of 3.72% is semi-annual. we'll make it annual by 3.72%*2 = 7.44‬%.

After-tax cost of bond 1 = YTM*(1-tax rate) = 7.44%*(1-0.38) = 7.44%*0.62 = 4.61%

cost of bond 2

N = maturity = 20*2 = 40; PV = market value = -$69,828,821.56, FV = face value = $75,900,893; PMT = semi-annual coupon = $75,900,893*(6%/2) = $2,277,026.79‬‬ > CPT= Compute > I/Y = semi-annual YTM = 3.37%

This YTM of 3.37% is semi-annual. we'll make it annual by 3.37%*2 = 6.74‬%.

After-tax cost of bond 1 = YTM*(1-tax rate) = 6.74%*(1-0.38) = 6.74%*0.62 = 4.18%

Cost of common stock

Cost of common stock = [recent dividend*(1+dividend growth rate)/current price] + dividend growth rate

Cost of common stock = [$2.47*(1+0.07)/$42.39] + 0.07 = [$2.47*1.07/$42.39] + 0.07 = ($2.6429‬/$42.39) + 0.07 = 0.0623 + 0.07 = 0.1323 or 13.23%

WACC = 0.09*4.61% + 0.13*4.18% + 0.78*13.23% = 0.4149% + 0.5434‬% + 10.3194% = 11.28%

Filer's WACC is 11.28%.