Vedder, Inc., has 7.4 million shares of common stock outstanding. The current sh
ID: 2646718 • Letter: V
Question
Vedder, Inc., has 7.4 million shares of common stock outstanding. The current share price is $62.40, and the book value per share is $5.40. Vedder also has two bond issues outstanding. The first bond issue has a face value of $71.4 million, a coupon rate of 7.4 percent, and sells for 91 percent of par. The second issue has a face value of $36.4 million, a coupon rate of 7.9 percent, and sells for 90 percent of par. The first issue matures in 18 years, the second in 10 years. The most recent dividend was $3.55 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 40 percent.
What is the company
Vedder, Inc., has 7.4 million shares of common stock outstanding. The current share price is $62.40, and the book value per share is $5.40. Vedder also has two bond issues outstanding. The first bond issue has a face value of $71.4 million, a coupon rate of 7.4 percent, and sells for 91 percent of par. The second issue has a face value of $36.4 million, a coupon rate of 7.9 percent, and sells for 90 percent of par. The first issue matures in 18 years, the second in 10 years. The most recent dividend was $3.55 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 40 percent.
Explanation / Answer
Answer WACC is 9.97%, calculated as below:
Step 1 - Calculating respective weights:
Market value of equity = No of shares * CMP = 7400000*62.4 = 461760000
Market value of debt = Market value of issue 1 + Market value of Issue 2 = 71400000*91% + 36400000*90% = 97734000
Total Market value of equity and debt = 461760000 +97734000 = 559494000
Now weight of equity = 461760000/559494000 = 82.5317% and weight of debt = 100%- 82.5317% = 17.4683%
Step 2: Cost of equity :
As we know Stock price = D0 (1+g)/(Ke-g)
So 62.4 = 3.7275/ (Ke-.05)
By solving this, we get Ke = 10.9736%
Step 3 : Cost of debt
We have 2 bond issues outstanding, we will calculate both's cost and then do weighted average cost of debt
We need to calculate yield to maturity for both bonds from below formula
For Bond 1, The YTM will be the rate at which the present value of all cash flows = 91. Half yearly coupon rate will be 7.4/2 = 3.7%, period will be 36, PV will be 91 and FV will be 100
91 = (3.7/(1+r) + 3.7/(1+r)power2 +.....+3.7/(1+r)power36 + 100/(1+r)power36
Solving this we get rate = 4.1885 half yearly rate, annualised rate will be 8.377%
After tax cost of issue 1 will be 8.377% (1-.4) = 5.02617%
Similerly, we will calculate Issue 2's cost
90 = (3.95/(1+r) + 3.95/(1+r)power2 +.....+3.95/(1+r)power20 + 100/(1+r)power20
Solving this we get rate = 4.7345 half yearly rate, annualised rate will be 9.4689%
After tax cost of issue 1 will be 9.4689% (1-.4) = 5.6814%
Now weighted average cost of debt = 5.0262% * 64974000/97734000 + 5.6814% * 32760000/97734000
= 5.2458%
Step 4: WACC = Equity weight * Cost of Equity + Debt weight * Cost of debt
= 82.5317% * 10.9736% + 17.4683% * 5.2458%
= 9.9730% is the answer
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