Question

Dinklage Corp. has 7 million shares of common stock outstanding. The current share price is $68, 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 97 percent of par. The second issue has a face value of $40 million, a coupon rate of 6.5 percent, and sells for 108 percent of par. The first issue matures in 21 years, the second in 6 years. Suppose the most recent dividend was $3.25 and the dividend growth rate is 5 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 21 percent. What is the company’s WACC?

Answer 1

WACC = 8.98%

Step-by-step explanation:

total value of equity = $68 x 7,000,000 = $476,000,000

cost of equity:

$68 = $3.4125 / (rrr - 5%)

rrr - 5% = 5.02%

rrr = 10.02%

total value of debt:

$70 million x 0.97 = $67,900,000

YTM = {60 + [(1,000 - 970)/21]} / [(1,000 + 970)/2] = 61.43 / 985 = 6.24%

$40 million x 1.08 = $43,200,000

YTM = {65 + [(1,000 - 1,080)/6]} / [(1,000 + 1,080)/2] = 51.67 / 1,040 = 4.97%

weighted cost of debt = ($67,900,000 / $111,100,000 x 6.24%) + ($43,200,000 / $111,100,000 x 4.97%) = 3.81% + 1.93% = 5.74%

total value of the firm = $476,000,000 + $67,900,000 + $43,200,000 = $587,100,000

equity weight = $476,000,000 / $587,100,000 = 0.81076

debt weight = 1 - 0.81076 = 0.18924

WACC = (0.81076 x 10.02%) + (0.18924 x 5.74% x 0.79) = 8.12% + 0.86 = 8.98%