Question

Dinklage Corp. has 9 million shares of common stock outstanding. The current share price is $69, and the book value per share is $8. The company also has two bond issues outstanding. The first bond issue has a face value of $70 million, a coupon rate of 6 percent, and sells for 94 percent of par. The second issue has a face value of $55 million, a coupon rate of 5 percent, and sells for 106 percent of par. The first issue matures in 24 years, the second in 9 years.Suppose the most recent dividend was $4.25 and the dividend growth rate is 4.4 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 25 percent. 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.)

Answer 1

The present value of a bond is found by discounting each of its future payments (interest and principal) by the discount rate. For an 8% coupon bond with yearly payments of $240 and a principal of $3,000, the present value is calculated for discount rates of 8% and 11%. A higher discount rate results in a lower present value for the bond.

Step-by-step explanation:

Calculating Present Value of a Bond

Calculating the present value (PV) of a bond involves discounting the future cash flows (interest payments and the principal repayment) back to their value in today's dollars. The formulas for calculating the present value of the interest payments and the principal are as follows:

PV of Interest Payments = Interest Payment × (1 - (1 + discount rate)^-number of periods) / discount rate

PV of Principal = Principal / (1 + discount rate)^number of periods

For a simple two-year bond with a face value of $3,000 and an annual 8% coupon rate, the bond will pay $240 in interest each year. Using discount rates of 8% and 11%, we will calculate the bond's present value.

Case 1: Discount Rate of 8%

• 
  
• Year 1 Interest PV = $240 / (1 + 0.08)
• 
  
• Year 2 Interest PV = $240 / (1 + 0.08)^2
• 
  
• Principal PV = $3,000 / (1 + 0.08)^2

Summing these calculations will give us the bond's present value at an 8% discount rate.

Case 2: Discount Rate of 11%

• 
  
• Year 1 Interest PV = $240 / (1 + 0.11)
• 
  
• Year 2 Interest PV = $240 / (1 + 0.11)^2
• 
  
• Principal PV = $3,000 / (1 + 0.11)^2

Again, adding these values will provide the bond's present value at an 11% discount rate.

The yield on a bond includes interest payments as well as capital gains or losses due to changes in the market interest rates.