Question

Study the Comprehensive WACC Example document attached in the Module 6 assignment tab on Canvas. After becoming comfortable with the concepts and calculations in this example, complete the activities below for this week’s participation assignment. (Following the Comprehensive WACC Example document for each step should make this assignment easier!)

1. Hearty Foods, Inc. (HFI) is a mid-cap consumer staples company started in 2008 to produce organic food products for major grocery chains. To capitalize their business, they have issued 21.5 million shares of common stock in the past three years and are currently trading on the NASDAQ exchange at $18.75 per share.

Calculate the equity market value of the company.

2. HFI has also issued 175,000 bonds over this same timeframe. Each bond was issued with a $1,000 face amount and a 20-year maturity.

What is the value of the debt portion of their capital structure?

3. HFI is trying to determine what their cost of equity is today. The current risk-free rate of return is 3.75% and the beta is 1.15. It is generally agreed that the expected market rate of return is 6.75%.

Using the CAPM formula, what would be BHT’s cost of equity?

4. The issued HFI bonds have interest rates ranging from 2.75% to 5.25% over this timeframe. In order to calculate the cost of debt, HFI decides to use the interest expense method. Referring to the most current income statement, the interest expense is $3.78 million and the long-term bonds value is $120 million.

Using this information, what is the cost of debt?

5. Using the same income statement, HFI can see their income before tax was $4.115 million. The income tax paid for the fiscal year was $1,008.175.

Calculate the income tax rate for BHT.

Determine the after-tax factor to use in the WACC formula.

6. The final inputs needed for the WACC formula is the weighted percentages of equity and debt.

Using the values above, calculate both percentages here.

Total market capitalization value

Weighted equity percentage

Weighted debt percentage

7. Now that you have gathered all of the inputs necessary for the WACC formula, calculate the WACC percentage. Show your work.

Weighted average cost of capital is a total cost of capital of a firm calculated on the basis of proportionally weight..Take the cost of debt or debentures net of tax. To determine the cost of debt..use the rate which company pays interest. So we can take a deduction of interest expenses while paying tax so there is a tax saving on it so we can deduct the amount of tax on it.

8. What does the weighted average cost of capital percentage mean to the owners of HFI?

Gilead Sciences, Inc. (GILD)                  $71.33

At close: July 2 4:03PM EDT

Income Statement

All numbers in thousands

Revenue	12/31/2017	12/31/2016	12/31/2015
Total Revenue	26,107,000	30,390,000	32,639,000
Cost of Revenue	4,371,000	4,261,000	4,006,000
Gross Profit	21,736,000	26,129,000	28,633,000
Operating Expenses
Research Development	3,734,000	5,098,000	3,014,000
Selling General and Administrative	3,878,000	3,398,000	3,426,000
Operating Income or Loss	14,124,000	17,633,000	22,193,000
Income from Continuing Operations
Total Other Income/Expenses Net	523,000	428,000	54,000
Earnings Before Interest and Taxes	14,647,000	18,061,000	22,347,000
Interest Expense	1,118,000	964,000	688,000
Income Before Tax	13,529,000	17,097,000	21,659,000
Income Tax Expense	8,885,000	3,609,000	3,553,000
Minority Interest	59,000	476,000	579,000
Net Income	4,628,000	13,501,000	18,108,000
Preferred Stock And Other Adjustments	-	-	-
Net Income	4,628,000	13,501,000	18,108,000

Shares outstanding:             1.3 billion

Beta:                                       1.39                

Answer 1

A) Equity market value = Issued shares of common stock * Price per share

Equity market value = 21.5 million shares * $18.75 per share

Equity market value = $403.125 million

B) Debt value = No. Of debts * face value

Debt value = 175000 no. Of debts * $1000

Debt value = $17,50,00,000 or $175 million

C) Cost of equity (CAPM) = Rf + Beta(Rm - Rf)

Here, Rf (Risk free rate) = 3.75% or 0.0375

Rm (Market return) = 6.75% or 0.0675

Beta = 1.15

Now,

Cost of equity = 0.0375 + 1.15(0.0675 - 0.0375)

Cost of equity = 0.0375 + 0.0345

Cost of equity = 0.0720 or 7.20%

D) Cost of debt = Interest expense / Bond value

Cost of debt = $3.78 million / $120 million

Cost of debt = 0.0315 or 3.15%

E)a) Income tax rate = Income tax / Income before tax

Here, Income tax = $1008.175

Income before tax = $4.115 million or $41,15,000

Now,

Income tax rate = $1008.175 / $41,15,000

Income tax rate = 0.000245 or 0.0245%

b) After tax factor : Cost of equity = 0.0720

Cost of debt (after tax) = Debt rate before tax * (1 - tax rate)

Cost of debt (after tax) = 0.0315 * (1 - 0.000245)

Cost of debt (after tax) = 0.0315 * 0.999755

Cost of debt (after tax) = 0.03149 or 3.149%

F) a) Total market value = Debt value + Equity value

Total market value = $175 million + $403.125 million

Total market value = $578.125 million

b) Weight equity(%) =Equity value/Total market value

Weight equity(%)= $403.125/$578.125 million

Weight equity (%) = 0.70 or 70%

c) Weight of debt(%) = Debt / Total market value

Weight of debt(%) = $175 / $578.125 million

Weight of debt (%) = 0.30 or 30%

G) WACC = (Weight of debt * After tax cost of debt) + (Weight of equity * Cost of equity)

WACC = (0.30 * 0.03149) + (0.70 * 0.0720)

WACC = 0.0095 + 0.0504

WACC = 0.0599 or 5.99%