Question

Fletcher Manufacturing has 9.2 million shares of common stock outstanding. The current share price is $37 and the book value per share is $6. Fletcher Manufacturing also has two bond issues outstanding. The first bond issue has a total face value of $70 million, a coupon rate of 6.5%, and sells for 101% of par. The second issue has a face value of $40 million, a coupon rate of 6%, and sells for 103% of par. The first issue matures in 12 years, the second in 7 years. Suppose the company's stock has a beta of 0.7. The risk-free rate is 4.2% and the market risk premium is 6.5%. Assume that the overall cost of debt is the weighted average implied by the two outstanding debt issues. Both bonds make semi-annual payments. The tax rate is 30%

What is the firm's market value weight of equity? (Report answer in percentage terms and round to 2 decimal places. Do not round intermediate calculations).

What is the firm's market value weight of debt? (Report answer in percentage terms and round to 2 decimal places. Do not round intermediate calculations).

What is the firm’s cost of equity? (Report answer in percentage terms and round to 2 decimal places. Do not round intermediate calculations).

What is the firm’s cost of debt? (Report answer in percentage terms and round to 2 decimal places. Do not round intermediate calculations).

What is the firm’s WACC? (Report answer in percentage terms and round to 2 decimal places. Do not round intermediate calculations. When using previous answers, use the rounded answer as it was given in the answer box).

Answer 1

The market value weight of equity is calculated as:

Market value weight of equity = (Number of shares outstanding * Price per share) / Total market value

Total market value = Market value of equity + Market value of debt

Market value of equity = Number of shares outstanding * Price per share

Market value of debt = First bond issue price + Second bond issue price

First bond issue price = $70,000,000 * 1.01 = $70,700,000

Second bond issue price = $40,000,000 * 1.03 = $41,200,000

Market value of debt = $70,700,000 + $41,200,000 = $111,900,000

Total market value = $111,900,000 + (9.2 million * $37) = $476,500,000

Market value weight of equity = (9.2 million * $37) / $476,500,000 = 71.79%

The market value weight of debt is calculated as:

Market value weight of debt = Market value of debt / Total market value

Market value weight of debt = $111,900,000 / $476,500,000 = 23.50%

The cost of equity is calculated using the CAPM:

Cost of equity = Risk-free rate + Beta * Market risk premium

Cost of equity = 4.2% + 0.7 * 6.5% = 8.47%

The overall cost of debt is the weighted average of the two outstanding debt issues:

Coupon payment for first bond issue = ($70,000,000 * 6.5%) / 2 = $2,275,000

Coupon payment for second bond issue = ($40,000,000 * 6%) / 2 = $1,200,000

Total coupon payment = $2,275,000 + $1,200,000 = $3,475,000

Weighted average coupon rate = ($70,000,000 * 6.5% + $40,000,000 * 6%) / ($70,000,000 + $40,000,000) = 6.44%

After-tax cost of debt = 6.44% * (1 - 0.30) = 4.51%

The WACC is calculated as:

WACC = (Market value weight of equity * Cost of equity) + (Market value weight of debt * Cost of debt