Question

Dani Corporation has 5 million shares of common stock outstanding. The current share price is $65, and the book value per share is $4. The company also has two bond issues outstanding. The first bond issue has a face value of $50 million, has a coupon rate of 5 percent, and sells for 90 percent of par. The second issue has a face value of $35 million, has a coupon rate of 4 percent, and sells for 102 percent of par. The first issue matures in 20 years, the second in 5 years.

Suppose the most recent dividend was $4.05 and the dividend growth rate is 3.9 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 21 percent. What is the company’s WACC?

Answer 1

The present value of a bond is the sum of its future cash flows discounted back to the present using a specific rate. An 8% discount rate would provide one present value, but if the discount rate rises to 11%, the present value would decrease. The total PDV divided by the number of shares provides the price per share.

Step-by-step explanation:

To calculate the present value of a simple two-year bond with a face value of $3,000 and an interest rate of 8%, we first determine the annual interest payment, which is $240 (3,000 × 8%). The present value of these cash flows is calculated using the discount rate. If we assume the discount rate is 8%, the present value of the bond's interest payments and principal repayment at the end of the second year can be calculated as follows:

PV = $240 / (1 + 0.08) + $240 / (1 + 0.08)^2 + $3,000 / (1 + 0.08)^2

Now, if the discount rate increases to 11%, the present value of the bond's cash flows would decrease, as shown in the recalculated equation:

PV = $240 / (1 + 0.11) + $240 / (1 + 0.11)^2 + $3,000 / (1 + 0.11)^2

To find the total present discounted value (PDV), we must add all the present values for each year. If we then had 200 shares and total profits with a PDV of $51.3 million, dividing this by the number of shares would give us a price per share of approximately $256,500.