Question

Dinklage Corp. has 8 million shares of common stock outstanding. The current share price is $82, and the book value per share is $6. The company also has two bond issues outstanding. The first bond issue has a face value of $135 million, a coupon rate of 7 percent, and sells for 93 percent of par. The second issue has a face value of $120 million, a coupon rate of 6 percent, and sells for 102 percent of par. The first issue matures in 25 years, the second in 9 years. Suppose the most recent dividend was $4.90 and the dividend growth rate is 5.4 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 WACC

Answer 1

MV of equity=Price of equity*number of shares outstanding

MV of equity=82*8000000

=656000000

MV of Bond1=Par value*bonds outstanding*%age of par

MV of Bond1=1000*135000*0.93

=125550000

MV of Bond2=Par value*bonds outstanding*%age of par

MV of Bond2=1000*120000*1.02

=122400000

MV of firm = MV of Equity + MV of Bond1+ MV of Bond 2

=656000000+125550000+122400000

=903950000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 656000000/903950000

W(E)=0.7257

Weight of debt = MV of Bond/MV of firm

Weight of debt = 247950000/903950000

W(D)=0.2743

Cost of equity

As per DDM

Price = recent dividend* (1 + growth rate )/(cost of equity - growth rate)

82 = 4.9 * (1+0.054) / (Cost of equity - 0.054)

Cost of equity% = 11.7

Cost of debt

Bond1

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =25x2

930 =∑ [(7*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^25x2

k=1

YTM1 = 7.63125385

Bond2

K = Nx2

Bond Price   =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =9x2

1020 =∑ [(6*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^9x2

k=1

YTM2 = 5.71

Firm cost of debt=YTM1*(MV bond1)/(MV bond1+MV bond2)+YTM2*(MV bond2)/(MV bond1+MV bond2)

Firm cost of debt=7.63125385*(125550000)/(125550000+122400000)+5.71*(125550000)/(125550000+122400000)

Firm cost of debt=6.68%

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 6.68*(1-0.23)

= 5.1436

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=5.14*0.2743+11.7*0.7257

WACC =9.9%