Dinklage Corp. has 10 million shares of common stock outstanding. The current sh

ID: 2748820 • Letter: D

Question

Dinklage Corp. has 10 million shares of common stock outstanding. The current share price is $82, and the book value per share is $5. The company also has two bond issues outstanding. The first bond issue has a face value of $85 million, a coupon rate of 5 percent, and sells for 97 percent of par. The second issue has a face value of $55 million, a coupon rate of 6 percent, and sells for 105 percent of par. The first issue matures in 20 years, the second in 9 years.

Suppose the most recent dividend was $5.40 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 38 percent. What is the company’s WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Comment: the answer is not 4.54 or 4.30

Explanation / Answer

The information provided allows us to solve for the cost of equity using the dividend growth model:

RE = D0(1+g)/P0+ g= $5.40(1+0.06)/$82+0.06

=$5.724/$82+0.06=0.0698+0.0600= 0.1298 or 12.98%.

Next we need to find the YTM on both bond issues:

Bond issue 1 = Face 85 million$, Coupan rate5%, market price 97%, 20 yr term.

Market value = 85 *0.97 = $ 82.45million

Annual interest paid (85million$*5/100)=$42,50,000.

After tax interest paid =42,50,000$x 62% = 26,35,000.

Net after tax cost = 26,35,000/ 82.45mil = 3..20%

Bond issue 1 = Face 55 million$, Coupan rate6%, market price 105%, 9 yr term.

Market value million = 55 * 1.05 = $57.75

Annual interest paid (55million$*6/100)=3,300,000$.

After tax interest paid =3,300,000$x 62% =2,046,000$ .

Net after tax cost = 2,046,000$/ 57.75mil = 3..54%

Calculate the weighted average cost of debt, we need to determine the market value weight of each bond issue. The market value weight of the first bond issue is the market value of bond issue 1 divided by the sum of market value of bond issue 1 and bond issue

Market Value of Equity= 10,000,000 shares * 82$ per share=82,000,000$

Market Value of Bond =85,000,000$*97%+55,000,000*105%=82,450,000$+57,750,000$=140,200,000$

The market value of Dinklage Corp is the sum of the market value of equity and market value of debt

V =82,000,000$+140,200,000$=222,200,000$

The market value weights of equity and debt are:

E / V= 82,000,000$/222,200,000$=37%

D / V=140,200,000$/222,200,000=63%

To calculate the weighted average cost of debt, we need to determine the market value weight of each bond issue. The market value weight of the first bond issue is the market value of bond issue 1 divided by the sum of market value of bond issue 1 and bond issue 2. We already know that the market value of both bond issues is $140,200,000. Therefore:

Bond 1= 82,450,000$/140,200,000$=59%

Bond 2= 57,750,000$/140,200,000$=41%

The post-tax weighted average cost of debt is:

Bond1(3.20*0.59+3.54*0.41)=3.34%

Using the WACC equation= WERE+WDRD(1-TC)=(0.3712.98)+ (0.63*3.34)= 6.9068

Company’s WACC is 6.9068

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