Question

Problem 14-13 Calculating the WACC [LO3] Dinklage Corp. has 4 million shares of common stock outstanding. The current share price is $70, and the book value per share is $9. The company also has two bond issues outstanding. The first bond issue has a face value of $75 million, a coupon rate of 7 percent, and sells for 95 percent of par. The second issue has a face value of $60 million, a coupon rate of 6 percent, and sells for 107 percent of par. The first issue matures in 25 years, the second in 8 years. Suppose the most recent dividend was $4.30 and the dividend growth rate is 4.5 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? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

The Weighted Average Cost of Capital (WACC) is the average rate of return required by a company's shareholders and lenders to invest in the company. To calculate the WACC, we need to determine the cost of equity and cost of debt, and then weigh them based on their proportions in the company's capital structure.

Step-by-step explanation:

The Weighted Average Cost of Capital (WACC) is the average rate of return required by a company's shareholders and lenders to invest in the company.

To calculate the WACC, we need to determine the cost of equity and cost of debt, and then weigh them based on their proportions in the company's capital structure.

First, let's calculate the cost of equity.

The dividend growth rate is given as 4.5%, so we can use the Gordon Growth Model: Cost of Equity = Dividend / Current Stock Price + Growth Rate.

This gives us (4.30 / 70) + 0.045 = 0.104.

Next, let's calculate the cost of debt. We need to find the yield to maturity for each bond issue.

For the first bond, the yield to maturity is 7% (the coupon rate), and for the second bond, the yield to maturity is 6% (the coupon rate).

Now, let's calculate the WACC.

The weight of equity is the market value of equity divided by the total market value: (4 million shares * $70) / ((4 million * $70) + ($75 million * 0.95) + ($60 million * 1.07)) = 0.60.

The weight of debt is the market value of debt divided by the total market value: (($75 million * 0.95) + ($60 million * 1.07)) / ((4 million * $70) + ($75 million * 0.95) + ($60 million * 1.07)) = 0.40.

Finally, the WACC can be calculated as: (0.60 * 0.104) + (0.40 * YTM) * (1 - Tax Rate), where YTM is the weighted average yield to maturity for the two bond issues.