Question

Hero Manufacturing has 8.4 million shares of common stock outstanding. The current share price is $78 and the book value per share is $5. The company also has two bond issues outstanding. The first bond issue has a face value of $65 million, a coupon rate of 6.5 percent and sells for 108.3 percent of par. The second issue has a face value of $50.3 million, a coupon rate of 7.7 percent and sells for 112.1 percent of par. The first issue matures in 9 years, the second in 27 years.

Suppose the company’s stock has a beta of 1.3. The risk-free rate is 2.7 percent and the market risk premium is 6.8 percent. Assume that the overall cost of debt is the weighted average implied by the two outstanding debt issues. Both bonds make semiannual payments. The tax rate is 21 percent. What is the company’s WACC? ****Please show how to solve with financial calculator where applicable**** This is the solve provided but there is no explanation as how the YTM was calculated: The market value of equity is the share price times the number of shares, so: S = 8,400,000($78) S = $655,200,000 Using the relationship that the total market value of debt is the price quote times the par value of the bond, we find the market value of debt is: B = 1.083($65,000,000) + 1.121($50,300,000) B = $126,781,300 This makes the total market value of the company: V = $655,200,000 + 126,781,300 V = $781,981,300 And the market value weights of equity and debt are: S/V = $655,200,000/$781,981,300 S/V = .8379 B/V = 1 – S/V = .1621 Next, we will find the cost of equity for the company. The information provided allows us to solve for the cost of equity using the CAPM, so: RS = .027 + 1.3(.068) RS = .1154, or 11.54% Next, we need to find the YTM on both bond issues. Doing so, we find: P1 = $1,083 = $32.50(PVIFAR%,18) + $1,000(PVIFR%,18) R = 2.664% YTM = 2.664% × 2 YTM = 5.33% P2 = $1,121 = $38.50(PVIFAR%,54) + $1,000(PVIFR%,54) R = 3.361% YTM = 3.361% × 2 YTM = 6.72% To find the weighted average aftertax cost of debt, we need the weight of each bond as a percentage of the total debt. We find: XB1 = 1.083($65,000,000)/$126,781,300 XB1 = .555 XB2 = 1.121($50,300,000)/$126,781,300 XB2 = .445 Now we can multiply the weighted average cost of debt times one minus the tax rate to find the weighted average aftertax cost of debt. This gives us: RB = (1 – .21)[(.555)(.0533) + (.445)(.0672)] RB = .0470, or 4.70% Using these costs and the weight of debt we calculated earlier, the WACC is: RWACC = .8379(.1154) + .1621(.0470) RWACC = .1043, or 10.43%

Answer 1

Step 1 : Weighted Average Cost of Capital :

Weighted Average Cost of Capital (WACC) represents its blended cost of capital across all sources, including common shares, preferred shares, and debt. The cost of each type of capital is weighted by its percentage of total capital and they are added together.

Step 2: Calculate the Pre-tax and post cost Debt for 2 bonds

The result for the above table is as follows :

Step 3: Calculate the cost of equity

Cost of equity is calculated using the CAPM equation.

Cost of equity = Rf + B (Rm - Rf)

Rf : Risk Free rate

B : Beta value

Rm - Rf : Market Risk Premium

The result of the above table is as follows :

Step 4: Calculate the Weighted Average Cost of Capital

The result of the above table is as follows :