Question

Bonaime, Inc., has 7.7 million shares of common stock outstanding. The current share price is $62.70, and the book value per share is $5.70. The company also has two bond issues outstanding. The first bond issue has a face value of $71.7 million, a coupon rate of 7.2 percent, and sells for 89.5 percent of par. The second issue has a face value of $36.7 million, a coupon rate of 8.2 percent, and sells for 88.5 percent of par. The first issue matures in 22 years, the second in 14 years. The most recent dividend was $3.70 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 30 percent.

What is the company’s cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Cost of equity %
What is the company’s aftertax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Aftertax cost of debt %
What is the company’s equity weight? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)
Equity weight
What is the company’s weight of debt? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.)
Debt weight
What is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
WACC

Answer 1

Bonaime, Inc.

1. The company's cost of equity = 5.90%

2. The company's after-tax cost of debt = 5.92%

3. The company's equity weight = 83.32%

4. The company's debt weight = 16.68%

5. The company's WACC = 5.9035%

Step-by-step explanation:

a) Data and Calculations:

Common stock outstanding = 7.7 million shares

Current share price = $62.70

Book value per share = $5.70

Most recent dividend per share = $3.70

1. Cost of equity = Dividend/Current share price = $3.70/$62.70 = 5.90%

Value:

Book value = 7.7 million * $5.70 = $43,890,000

Market value = 7.7 million * $62,70 = $482,790,000

Bonds outstanding: First Bonds Second Bonds Total

Face value = $71,700,000 $36,700,000 $108,400,000

Coupon rate 7.2% 8.2%

Annual coupon payment $5,162,400 $3,009,400 $8,171,800

Market value per bond 89.5% 88.5%

Market value of bonds $64,171,500 $32,479,500 $96,651,000

Before tax cost of debt = $8,171,800/$96,651,000 = 0.08455

2. After tax cost of debt = 5.92% (0.08455 * (1 - 0.30))

3. The company's equity weight = Equity Market Value/Total Firm's Value

= $482,790,000/$579,441,000

= 83.32%

4. The company's debt weight = 1 - 0.8332

= 16.68%

5. The company's WACC = Cost of equity * Weight + Cost of Debt * Weight

= (5.90% * 83.32%) + (5.92% * 16.68%)

= (0.0590 * 0.8332) + (0.0592 * 0.1668)

= 0.04916 + 0.009875

= 0.059035

= 5.9035%

b) The costs of equity and debts are based on their market values instead of the book value. The market values are always more relevant in capital decision-making than the book values.