Question

Estimating WACC and Expected Growth in Dividends ModelAssume FedEx Corporation (NYSE: FDX) was trading at $107.47 at May 31, 2011. Its dividend per share was $0.36, its market beta was estimated to be 0.7, its average borrowing rate is 9.5%, and its marginal tax rate is 36%. FedEx's market value of equity (market cap) is $32.95 billion and its total market value (enterprise value) is $34.31 billion. Assume a risk-free rate of 5.4% and a market risk premium of 5.8% to answer the following requirements.(a) Estimate FedEx's cost of debt capital, cost of equity capital, and weighted average cost of capital. (Round your answers to one decimal place.)Cost of debt capital = Answer%Cost of equity capital = Answer%Calculate the weighted average cost of capital. (Use rounded answers from above. Do not round until your final answer. Round to one decimal place.)Weighted average cost of capital = Answer%(b) Using the dividend discount model, and assuming a constant perpetuity for dividends, estimate FedEx's intrinsic value per share. (Use the rounded cost of equity capital calculated in (a). Round your answer to two decimal places.)$Answer(c) Using the Gordon growth DDM, and assuming next period's dividends equal $0.36 and grow at a constant rate for each period thereafter, infer the market's expected growth in dividends that are necessary for FedEx's intrinsic value from the model to equal $107.47 per common share. Assume that its cost of equity capital is 9.5%. (Do not round until your final answer. Round to one decimal place.)

Answer 1

Cost of borrowing = 9.5%

Tax rate = 36%

After tax cost of debt = 9.50% × (1 – 36%)

= 6.08%

After tax cost of debt is 6.08%

Risk free rate = 5.40%

Market risk premium = 5.80%

For Stock X

Beta = 0.7

Cost of equity for FedEx is calculated below using CAPM Model:

Cost of equity = Risk free rate + Risk Premium × Beta

= 5.40% + 5.80% × 0.7

= 5.40% + 4.06%

= 9.46%

Cost of equity for FedEx is 9.46%.

Market cap = $32.95 billion

Enterprise value = $34.31 billion

Value of debt = $1.36 billion

Weight of debt in capital structure = 3.96%

Weight of equity in capital structure = 96.04%

Now WACC is calculated below:

WACC = (96,04% × 9.46%) + (3.96% × 6.08%)

= 9.09% + 0.24%

= 9.33%

WACC for company is 9.33%.

b.

Current dividend = $0.36

Cost of equity = 9.46%

Assuming a constant perpetuity for dividends, estimate FedEx's intrinsic value per share is calculated below:

Intrinsic value = $0.36 / 9.46%

= $3.81

Assuming a constant perpetuity for dividends, estimate FedEx's intrinsic value per share is $3.81.

c.

[ Find the given attachment for part c]

Note: Value of debt = Total value of firm - Value of equity