Question

iler Manufacturing has 4 million shares of common stock outstanding. The current share price is $76, and the book value per share is $5. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $90 million, has a 5 percent coupon, and sells for 94 percent of par. The second issue has a face value of $70 million, has a 6 percent coupon, and sells for 104 percent of par. The first issue matures in 20 years, the second in 3 years. The most recent dividend was $4.8 and the dividend growth rate is 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 35 percent. Required: What is the company's WACC? (Do not round your intermediate calculations.)

Answer 1

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

MV of equity=76*4000000

=304000000

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

MV of Bond1=1000*90000*0.94

=84600000

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

MV of Bond2=1000*70000*1.04

=72800000

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

=304000000+84600000+72800000

=461400000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 304000000/461400000

W(E)=0.6589

Weight of debt = MV of Bond/MV of firm

Weight of debt = 157400000/461400000

W(D)=0.3411

Cost of equity

As per DDM

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

76 = 4.8 * (1+0.08) / (Cost of equity - 0.08)

Cost of equity% = 14.82

Cost of debt

Bond1

K = Nx2

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

k=1

K =20x2

940 =∑ [(5*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^20x2

k=1

YTM1 = 5.4983086304

Bond2

K = Nx2

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

k=1

K =3x2

1040 =∑ [(6*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^3x2

k=1

YTM2 = 4.56

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

Firm cost of debt=5.4983086304*(84600000)/(84600000+72800000)+4.56*(84600000)/(84600000+72800000)

Firm cost of debt=5.06%

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

After tax cost of debt = 5.06*(1-0.35)

= 3.289

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

WACC=3.29*0.3411+14.82*0.6589

WACC =10.89%