Question

Johnny Cake Ltd. has 10 million shares of stock outstanding selling at $22 per share and an issue of $50 million in 8 percent annual coupon bonds with a maturity of 18 years, selling at 90.5 percent of par. Assume Johnny Cake’s weighted-average tax rate is 34 percent, its next dividend is expected to be $3 per share, and all future dividends are expected to grow at 4 percent per year, indefinitely.

What is its WACC? (Do not round intermediate calculations. Round your final answer to 2 decimal places.)

Answer 1

Number of shares outstanding = 10 Million shares = 10,000,000 Shares Current price of stock = $22 Per share Expected next dividend, D1 = $3 Per share Growth rate, g = 4% Cost of equity , Ke = D1 /PO) + g = ($3 / $22) + 4% = 0.136363636 + 0.04 = 0.17636363 = 17.63636% Total market value of equity = 10,000,000 Shares * $22 Per share = $220,000,000 Face value of bonds = $50 Million Coupon rate = 8% Term = 18 Years Current price of bond = Face value * 90.5% = $50 Million * 90.5% = $45.25 Million YTM = [Coupon amount + Maturity value - Current price) / Term ]/[0.6 * Current price + 0.4 * Maturity value] = [$4 Million + ($50 Million - $45.25 Million)/18 1/[ 0.6 * $45.25 Million + 0.4 * $50 Million = $4.263888889 Millions / $47.15 Millions = 0.090432426 = 9.0432426 %

Total market value of firm = Total market value of equity + Total market value of debt = $220 Million + $45.25 Million = $265.25 Million Weight of debt. Wd = $45.25 Million / $265.25 Million = 0.170593779 Weight of equity, We = $220 Million / $265.25 Million = 0.829406221 WACC = wd* Kd+ We * Ke = 0.170593779 * 5.9685401 % +0.829406221 * 17.63636 % = 1.018195817 % + 14.62770971 % = 15.64590552 % = 15.65 % Ans : WACC = 15.65%