Question

Easy Car Corp. is a grocery store located in the Southwest. It paid an annual dividend of ​$3.00 last year to its shareholders and plans to increase the dividend annually at the rate of 5.0​%. It currently has 2,000,000 common shares outstanding. The shares currently sell for ​$12 each. Five years ago, Easy Car Corp. issued 50,000 semiannual 28-year bonds with a coupon rate of 10​% and a par value of ​$1,000. The bonds currently have a yield to maturity​ (YTM) of 11%. What is the weighted average cost of capital (WACC) for Easy Car Corp. if the corporate tax rate is 20%?

Answer 1

According to dividend discount model

P0 = D0*(1+g)/(r-g)

Where, P0 is current stock price

D0 is the recently dividend paid

g is the growth rate

r is required return

Therefore, r = (D0*(1+g)/P0)+g

= (3*(1+0.05)/12)+0.05

= 31.25%

Current price of the Bond is calculated using excel below

Therefore, current price of the Bond = $917.34

Market value of 50000 Bond(MVD) = 50000*917.34 =$45867000

Market value of Equity(MVE) = 2000000*$12 = $24000000

% of Debt = Market value of Debt/(Market value of Debt+Market value of Equity)

= 45867000/(45867000+24000000) = 0.6565 or 65.65%

% of Equity = 1-% of Debt = 1-0.6565 = 0.3435 or 34.35%

WACC = Cost of Equity*% of Equity + Cost of Debt*% of Debt*(1-tax rate)

= 31.25*0.3435 +11*0.6565*(1-0.20)

= 16.51%