Question

In: Finance

M&M has 570,000 shares of common stock outstanding at a market price of $31.8 a share....

M&M has 570,000 shares of common stock outstanding at a market price of $31.8 a share. Last month, Hershey paid an annual dividend in the amount of $1.85 per share. The dividend growth rate is 6.2%. Hershey also has 25,000 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 5.4% coupon, pay interest annually, and mature in 10 years. The bonds are selling at 99% of face value. The company's tax rate is 25%. What is Hershey's weighted average cost of capital?

A. 7.42% B. 7.63% C. 7.85% D. 8.04% E. 8.26%

Solutions

Expert Solution

Market value of equity= 570,000*$31.8= $18,126,000

Market value of bond= $0.99*1,000= $990

Market value of debt= 25,000*$990= $24,750,000

Total firm capital= 18,126,000 + $24,750,000

                                 = $42,876,000

Weight of equity in the capital structure= $18,126,000/ $42,876,000

                                                                             = $0.4228*100

                                                                             = 42.28%

Weight of debt in the capital structure= $24,750,000/ $42,876,000

                                                                          = 0.5772*100

                                                                          = 57.72%

The cost of equity is calculated using the dividend discount model. It is calculated using the below formula:

Ke=D1/Po+g

where:

D1= Next year’s dividend

Po=Current stock price

g=Firm’s growth rate

Ke= Cost of equity

Ke= $1.85*(1 + 0.062)/ $31.8 + 0.062

     = $1.9647/ $31.8 + 0.062

     = 0.0618 + 0.062

     = 0.1238*100

     = 12.38%

The cost of debt is calculated by computing the yield to maturity.

The yield to maturity is computed by entering the below in a financial calculator:

FV= 1,000

PMT= 54

N= 10

PV= -990

Press the CPT key and I/Y to compute the yield to maturity.

The value obtained is 5.5329.

Therefore, the yield to maturity is 5.53%.

WACC is calculated by using the formula below:

WACC= wd*kd(1-t)+we*ke

Where:

Wd=percentage of debt in the capital structure

We=percentage of equity in the capital structure

Kd=cost of debt

Ke=cost of equity

t= tax rate

WACC= 0.5772*5.53%*(1 – 0.25) + 0.4228*12.38%

            = 2.3939% + 5.2343%

            = 7.6282%    7.63%

Hence, the answer is option b.

In case of any query, kindly comment on the solution.

jeff jeffy answered 1 year ago
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