Question

Masterson, Inc., has 4.1 million shares of common stock outstanding. The current share price is $88.00, and the book value per share is $10.50. The company also has two bond issues outstanding. The first bond issue has a face value of $78 million, a coupon rate of 5.4 percent, and sells for 96.2 percent of par. The second issue has a face value of $50 million, a coupon rate of 6.1 percent, and sells for 105.9 percent of par. The first issue matures in 22 years, the second in 11 years. The most recent dividend was $4.19 and the dividend growth rate is 4.8 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 23 percent.

What is the company’s cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

  
What is the company’s aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

  
What is the company’s weight of equity? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

  
What is the company’s weight of debt? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)

  
What is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Masterson, Inc

What is the company’s cost of equity?

The current share price is $88.00

The most recent dividend was $4.19

dividend growth rate is 4.8 percent

Here we can use constant dividend growth model of calculating cost of equity

2. Cost of Common stock: = ( D1 / P ) + G

Here,

D1 = next year dividend = Most recent dividend + growth rate = $ 4.19 + 4.8% = 4.39112

P = Current price = 88

G = growth rate = 4.8% = 0.048

Cost of Common stock: = ( 4.39112 /   88 ) + 0.048

Cost of Common stock: = 0.0498 + 0.048 = 0.0979 = 9.80%

The firm is in the 23% tax bracket.

*The company also has two bond issues outstanding. The first bond issue has a face value of $78 million, a coupon rate of 5.4 percent, and sells for 96.2 percent of par.

*The second issue has a face value of $50 million, a coupon rate of 6.1 percent, and sells for 105.9 percent of par

* The first issue matures in 22 years, the second in 11 years

*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.

2. Calculation of cost of debt

interest = one year interest / current price

1st bond cost = (78 * 5.4%) / ( 78 * 96.2%) = 4.212 / 75.036 = 0.0561 = 5.61%

2nd bond cost = ( 50*6.1%) / (50*105.9%) = 3.05 / 52.95 = 0.0576 = 5.76%

Weight of bond in debt (in market value)

Total debt = 75.036 + 52.95 = 127.986

1st bond weight = 75.036 / 127.986 = 0.5863 = 58.63%

2nd bond weight = 52.95 / 127.986 = 0.4137 = 41.37%

weighted average cost of debt = ( 5.61%* 58.63%) + 5.76% * 41.37%) = 5.67%

After tax cost of debt = 5.67% - 23% = 4.37%

3. What is the company’s weight of equity?  

(Weight is calculating market value basis)

weight of equity = equity components value / total market value

Equity total market value = 4100000 * 88 = 360800000

Total market value of capital = debt + equity

Total market value = 360800000 + 127986000 = 488786000

weight of equity = 360800000 / 488786000 = 0.738155 = 73.8255%

4. What is the company’s weight of debt?

Total debt = 75.036 + 52.95 = 127.986 million = 127986000

Total market value = 360800000 + 127986000 = 488786000

weight of debt = debt components value / total market value

weight of debt = 127986000 / 488786000 = 0.261845 = 26.1845%

5. What is the company’s WACC?

WACC = (cost of debt * weight ) + ( cost of equity * weight)

cost of debt = 4.37%

cost of equity = 9.80%

WACC = ( 4.37% * 26.1845% ) + (9.80% * 73.8255% )

WACC = 1.14426 + 7.2349 = 8.38%