Erna Corp. has 9 million shares of common stock outstanding. The current share p
ID: 2635195 • Letter: E
Question
Erna Corp. has 9 million shares of common stock outstanding. The current share price is $75, and the book value per share is $6. Erna Corp. also has two bond issues outstanding. The first bond issue has a face value of $85 million, has a coupon rate of 10 percent, and sells for 96 percent of par. The second issue has a face value of $65 million, has a coupon rate of 11 percent, and sells for 109 percent of par. The first issue matures in 25 years, the second in 9 years.
Suppose the most recent dividend was $4.70 and the dividend growth rate is 6 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 9 million shares of common stock outstanding. The current share price is $75, and the book value per share is $6. Erna Corp. also has two bond issues outstanding. The first bond issue has a face value of $85 million, has a coupon rate of 10 percent, and sells for 96 percent of par. The second issue has a face value of $65 million, has a coupon rate of 11 percent, and sells for 109 percent of par. The first issue matures in 25 years, the second in 9 years.
Suppose the most recent dividend was $4.70 and the dividend growth rate is 6 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
cost of the first bond
85*.96 = 85*.1/2*PVIFA(i/2,50) + 85*PVIF(i/2,50) = 85*.1/2*(1-(1+i/2)^(-50))/(i/2) + 85*(1+i/2)^(-50)
i = 10.4537%
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cost of the second bond
65*1.09 = 65*.11/2*PVIFA(i/2,18) + 65*PVIF(i/2,18) = 65*.1/2*(1-(1+i/2)^(-18))/(i/2) + 65*(1+i/2)^(-18)
i = 9.4907%
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cost of stock
According to the dividend growth model
P0 = D1/(R-g) = D0*(1+g)/(R-g)
75 = 4.7*(1+.06)/(R-.06)
R = 12.6427%
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market value of the first bond = 85*.96 = 81.6
market value of the second bond = 65*1.09 = 70.85
market value of debt = 81.6 + 70.85 = 152.45
cost of debt = 10.4537%*81.6/152.45 + 9.4907%*70.85/152.45 = 10.0062%
market value of equity = 9*75 = 675
WACC = 10.0062%*(1-.34)*152.47/(152.45+675) + 12.6427%*675/(152.45+675) = 11.53%
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