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icore: 0 of 10 pts y of 12 (y compete) MW score: 39%, 3Y OT 100 P X P11-19 (similar to) Question Help Adjusted WACC. Hollydale's is a clothing store in East Park. It paid an annual dividend of $1.70 last year to its shareholders and plans to increase the dividend annually at 5.0%. It has 460,000 shares outstanding. The shares currently sell for $23.34 per share. Hollydale's has 12,000 semiannual bonds outstanding with a coupon rate of 11.5%, a maturity of 25 years, and a par value of $1,000. The bonds are currently selling for $1,136.92 per bond. What is the adjusted WACC for Hollydale's if the corporate tax rate is 15%? What is the adjusted WACC for Hollydale's if the corporate tax rate is 15%? % (Round to two decimal places.)

Answer 1

Market value of equity E = Number of shares * stock price = 460,000 *$23.34

= $10,736,400

Market value of debt = 1,200 * $1,136.92 = $13,643,040

Total value of firm (E+ D) = Market value of equity + Market value of debt

= $10,736,400 + $13,643,040

= $24,379,440

We need to find the YTM on both bond issues

Before tax cost of debt is bond’s yield; we have following formula for calculation of bond’s yield

Bond price P0 = C* [1- 1/ (1+i) ^n] /i + M / (1+i) ^n

Where

Market Price of the bond P0 = $1,136.

C = coupon payment = 11.5% of $1000 = $115; semiannual coupon = $115/2 = $57.50

n = number of payments = 25 years *2 = 50

i = interest rate, or yield to maturity =?

M = value at maturity, or par value = $1,000

Now we have,

$1,136.92 = $57.50 * [1 – 1 / (1+i) ^50] /i + $1,000 / (1+i) ^50

We got the value of i = 5% (semiannual)

Or annual YTM = 10.00%

Tax rate = 15%

Therefore After tax cost of debt = 10% *(1-0.15) = 8.50%

We can use the dividend growth model for our calculation

Cost of equity, re = D 1 / P0 + g

Where re = cost of equity =?

D1 = expected dividend amount = D0 * (1+g) where D0 is current dividend paid = $1.70

P0 = Current market value of stock = $23.34

And g = Dividend growth rate = 5% or 0.05

Therefore

Cost of equity re = $1.70 * (1+.05) /$23.34 + 0.05

= 0.0765 +0.05

= 0.1265 or 12.65%

Weighted Average Cost of Capital (WACC)

WACC = [E/ (E+D)] * re + [D/ (E+D)] * rd

Where, re is the cost of equity

rd is the after tax cost of debt

E is the value of common equity

D is the value of debt

WACC = ($10,736,400 / $24,379,440) * 12.65% + ($13,643,040 / $24,379,440) * 8.50 %

= 5.57% + 4.76%

= 10.33%

Therefore adjusted Weighted Average Cost of Capital (WACC) of firm is 10.33%