Vedder, Inc., has 6.4 million shares of common stock outstanding. The current sh
ID: 2719797 • Letter: V
Question
Vedder, Inc., has 6.4 million shares of common stock outstanding. The current share price is $61.40, and the book value per share is $4.40. Vedder also has two bond issues outstanding. The first bond issue has a face value of $70.4 million, a coupon rate of 7.4 percent, and sells for 96 percent of par. The second issue has a face value of $35.4 million, a coupon rate of 6.9 percent, and sells for 95 percent of par. The first issue matures in 18 years, the second in 10 years. The most recent dividend was $3.05 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’s cost of equity? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
What is the company’s aftertax cost of debt? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
What is the company’s equity weight? (Do not round intermediate calculations. Enter your answer rounded to 4 decimal places (e.g., .1632).)
What is the company’s weight of debt? (Do not round intermediate calculations. Enter you answer rounded to 4 decimal places (e.g., .1632).)
What is the company’s WACC? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
Vedder, Inc., has 6.4 million shares of common stock outstanding. The current share price is $61.40, and the book value per share is $4.40. Vedder also has two bond issues outstanding. The first bond issue has a face value of $70.4 million, a coupon rate of 7.4 percent, and sells for 96 percent of par. The second issue has a face value of $35.4 million, a coupon rate of 6.9 percent, and sells for 95 percent of par. The first issue matures in 18 years, the second in 10 years. The most recent dividend was $3.05 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
1) company’s cost of equity : using the divident discount model we get cost of equity as Ke =( D1 / P0 ) + g
D1 = Next yrs Dividend. In this question the most recent divident paid is $3.05 and the growth rate of dividend is 5%. therefore D1 , i.e. next yrs dividend = 3.05*(1.05) = $3.2
P0 = Market value of share
There for Ke = (3.2/61.4) + 5 = 5.21% + 5% =10.21%
2) What is the company’s aftertax cost of debt?
It is important to note that the YTM (yield to maturity) is the cost of debt (in the year in which it is issued and not in subsequent years) and not the coupon rate on the firms existing debt.
The first bond issue has a face value of $70.4 million, and sells for 96 percent of par and matures in 18 years.
MV = 0.96 of $70.4 Mn = $67.58Mn
Coupon rate is 7.4% of $70.4 Mn = 5.21 Mn / year = 2.605 Mn semi annually
using PV equation, 67.58 = PV of 2.605Mn for 36 compounding periods + 70.4Mn at end of 36 compounding periods , therefore we can compute the YTM using BAII Plus Texas Instrument calculator
1) Press CF and 2ND and CLR WORK again 2ND and QUIT to clear memory
2) Press CF and type - 67.58 and press ENTER (CF0 = -67.58)
3) Press the down arrow key (you will see C01)
4) type 2.605 press ENTER and the Down arrow key
5) type 35 and press ENTER (i.e. set F01 as 35 compounding periods)
6) Type 73.005 (70.4 + 2.605 as it comes in 36th period) and press ENTER (i.e. set C02 as maturity amount of 73.005)
7) Press IRR and then press CPT
The semi annual compounding rate is 3.909% but we need annual rate. For annual rate we compute as follows (1.03909)2 - 1 = 7.972% , which is the YTM or the cost of debt. After tax cost of debt is (1- tax rate)* YTM = 0.6 * 7.972% = 4.78%
Similarly, for the second issue has a face value of $35.4 million, and sells for 95 percent of par and matures in 10 years.
MV = .95* 35.4 = 33.63Mn; Coupon payment is 6.9/ yr therefore semi annual rate is 3.45%
using the PV equation again, we get
33.63 = PV of 1.22 Mn for 20 compounding periods + PV of maturity amount of 35.4 Mn
1) Press CF and 2ND and CLR WORK again 2ND and QUIT to clear memory
2) Press CF and type - 33.63 and press ENTER (CF0 = -33.63)
3) Press the down arrow key (you will see C01)
4) type 1.22 press ENTER and the Down arrow key
5) type 19 and press ENTER (i.e. set F01 as 19 compounding periods)
6) Type 36.62 (35.4 + 1.22 of the 20th period) and press ENTER (i.e. set C02 as maturity amount of 36.62)
7) Press IRR and then press CPT
The semi annual compounding rate is 3.81% but we need annual rate. For annual rate we compute as follows (1.0381)2 - 1 = 7.76% , which is the YTM or the cost of debt. After tax cost of debt is (1- tax rate)* YTM = 0.6 * 7.76% = 4.66%
Overall cost of debt is wght. avg. Foe the weights we will consider both time and value of debt.
so weight 1(w1) = 18yrs * 70.4 Mn and weight 2 (w2)= 10 yrs *35.4 Mn total weight( W) = weight 1 + weight 2
So avg cost of debt = (w1/W)*4.78% + (w2/W)*4.66%
= 0.78 * 4.78% + 0.22 * 4.66% =4.75%
What is the company’s equity weight?
Total Market value of equity/(total Market value of Equity + Debt)
= (6.4 share * 61.4 /share)/((6.4*61.4) + 70.4 + 35.4)
=392.96/(392.96+105.8) = 79%
therefore weight of Debt is 1 - 0.79 = 21%
WACC = (weight of weuity * cost of equity) + (weight of debt * after tax cost of debt)
= (.79* 10.21) + (.21*4.75) = 9.06%
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