Erna Corp. has 8 million shares of common stock outstanding. The current share p

Question

Erna Corp. has 8 million shares of common stock outstanding. The current share price is $80, and the book value per share is $7. Erna Corp. also has two bond issues outstanding. The first bond issue has a face value of $75 million, has a coupon rate of 9 percent, and sells for 95 percent of par. The second issue has a face value of $45 million, has a coupon rate of 10 percent, and sells for 108 percent of par. The first issue matures in 24 years, the second in 7 years.

Suppose the most recent dividend was $5.20 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 34 percent. What is the company

Erna Corp. has 8 million shares of common stock outstanding. The current share price is $80, and the book value per share is $7. Erna Corp. also has two bond issues outstanding. The first bond issue has a face value of $75 million, has a coupon rate of 9 percent, and sells for 95 percent of par. The second issue has a face value of $45 million, has a coupon rate of 10 percent, and sells for 108 percent of par. The first issue matures in 24 years, the second in 7 years.

Suppose the most recent dividend was $5.20 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 34 percent. What is the company

Explanation / Answer

Market value of equity = 8*80 = 640 million

Bond 1 market value = 75*95% = 71.25 million

Bond 2 market value = 45*108% = 48.6 million

Total market value of firm = 640 + 71.25 + 48.6 = 759.85 million

Cost of equity = 5.20 * (1+8%) / 80 + 8% = 15.02%

Yield of bond 1 can be calculated in Excel as =RATE(24*2,-9%*1000/2,950,-1000)*2. This is equal to 9.53%.

After tax cost of bond 1 = 9.53% * (1-34%) = 6.29%

Yield of bond 2 can be calculated in Excel as =RATE(7*2,-10%*1000/2,1080,-1000)*2. This is equal to 8.46%.

After tax cost of bond 1 = 8.46% * (1-34%) = 5.58%

So WACC = cost of equity * weight of equity + cost of bond 1 * after tax cost of bond 1 + cost of bond 2 * after tax cost of bond 2 = 15.02% * 640 / 759.85 + 6.29% * 71.25 / 759.85 + 5.58% * 48.6 / 759.85 = 13.60%

Answer: WACC = 13.60%

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