Question

Dinklage Corp. has 4 million shares of common stock outstanding. The current share price is $76, and the book value per share is $5. The company also has two bond issues outstanding. The first bond issue has a face value of $90 million, a coupon rate of 5 percent, and sells for 94 percent of par. The second issue has a face value of $70 million, a coupon rate of 6 percent, and sells for 104 percent of par. The first issue matures in 20 years, the second in 3 years.Suppose the most recent dividend was $4.80 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 35 percent. What is the company’s WACC?

Answer 1

WACC = 10.88%

Step by Step Process:

Firstly, we need to calculate the market weights of both equity and debt

Total equity = 4,000,000 * 76 = 304,000,000

Bond 1 issue = 90,000,000 *0.94 = 84,600,000

Bond 2 issue = 70,000,000 * 1.04 = 72,800,000

Total debt = 84,600,000 + 72,800,000 = 157,400,000

Total assets = 157,400 + 304,000,000 = 461,400,000

Weight of equity = We = 304/461.4 = 0.6589

Weight of bond 1 = Wb1 = 84.6/461.4 = 0.1833

Weight of bond 2 = Wb2 = 1-0.6589 -0.1833 = 0.1578

Cost of equity = Re = D1/P0 + g = 4.80*1.08/76 + 0.08 = 0.1482 = 14.82%

Cost of bond 1 = rate(nper,pmt,pv,fv) where nper = 20* 2 = 40, pmt =5% of 1000 = 50 = 25(semi annual), pv = 940 and FV =1000

Cost of bond 1= Rb1 = rate(40,25,-940,1000) *2 = 5.4983%

Cost of bond 2 = rate(nper,pmt,pv,fv) where nper = 3* 2 = 6, pmt =6% of 1000 = 60 = 30(semi annual), pv = 1040 and FV =1000

Cost of bond 2 = Rb2 =rate(6,30,-1040,1000)*2 = 4.5583%

WACC = We* Re + Wb1* Rb1*(1-tax rate) + Wb2*Rb2 *(1-tax rate) { Since debt has tax advantage}

WACC = 0.6589*14.82% + 0.1833 * 5.4983% *(1-0.35) + 0.1578*4.5583%*(1-0.35)

WACC = 10.8875%

WACC = 10.88%