Erna Corp. has 4 million shares of common stock outstanding. The current share p

Question

Erna Corp. has 4 million shares of common stock outstanding. The current share price is $83, and the book value per share is $8. Erna Corp. also has two bond issues outstanding. The first bond issue has a face value of $90 million, has a coupon rate of 6 percent, and sells for 98 percent of par. The second issue has a face value of $60 million, has a coupon rate of 7 percent, and sells for 106 percent of par. The first issue matures in 21 years, the second in 3 years.

Suppose the most recent dividend was $5.50 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 35 percent. What is the company

Erna Corp. has 4 million shares of common stock outstanding. The current share price is $83, and the book value per share is $8. Erna Corp. also has two bond issues outstanding. The first bond issue has a face value of $90 million, has a coupon rate of 6 percent, and sells for 98 percent of par. The second issue has a face value of $60 million, has a coupon rate of 7 percent, and sells for 106 percent of par. The first issue matures in 21 years, the second in 3 years.

Suppose the most recent dividend was $5.50 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 35 percent. What is the company

Explanation / Answer

Hi,

Please find the answer as follows:

Cost of Debt

First Bond:

Nper = 21*2 = 42

PMT = 1000*6%*1/2 = 30

PV = 1000*.98 = 980

FV = 1000

Rate = ?

After Tax Cost of First Bond = Rate(Nper,PMT,PV,FV) = Rate(42,30,-980,1000)*2*(1-.35) = 4.011%

Second Bond:

Nper = 3*2 = 6

PMT = 1000*7%*1/2 = 35

PV = 1000*106% = 1060

FV = 1000

Rate = ?

After Tax Cost of First Bond = Rate(Nper,PMT,PV,FV) = Rate(6,35,-1060,1000)*2(1-.35) = 3.138%

Cost of Equity = D1/Current Selling Price + Growth Rate = 5.50*(1+.05)/83 + .05 = 11.958%

Value of Bond 1 = 90000000*98% = 88200000

Value of Bond 2 = 60000000*106% = 63600000

Value of Equity = 4000000*83 = 332000000

Total Value = 88200000 + 63600000 + 332000000 = 483800000

WACC = After Tax Cost of Debt*Weight of Debt + Cost of Equity*Weight of Equity = (4.011*88200000/483800000 + 3.138*63600000/483800000) + 11.958*332000000/483800000 = 9.35%

Answer is 9.35%

Thanks.

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