Vedder, Inc., has 7.9 million shares of common stock outstanding. The current sh
ID: 2751695 • Letter: V
Question
Vedder, Inc., has 7.9 million shares of common stock outstanding. The current share price is $62.90, and the book value per share is $5.90. Vedder also has two bond issues outstanding. The first bond issue has a face value of $71.9 million, a coupon rate of 7.4 percent, and sells for 88.5 percent of par. The second issue has a face value of $36.9 million, a coupon rate of 8.4 percent, and sells for 87.5 percent of par. The first issue matures in 18 years, the second in 10 years. The most recent dividend was $3.80 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 WACC?
Explanation / Answer
WACC = r(E) × w(E) + r(D) × (1 – t) × w(D)
Current Market Value of Equity = 7.9 Million × $62.90 = $ 496.91 million
Current Market Value of Debt = (71.90*88.5%+36.9*87.5%) = $ 95.91 Million
Total Market Value of Debt and Equity = $ 592.81 Million
Weight of Equity = $ 496.91 Million / $592.81 Million = 83.82%
Weight of Debt = $ 95.91 / $592.81 Million = 16.18%,
Cost of Equity = Risk Free Rate + Beta × Market Risk Premium
We can estimate cost of equity using either dividend discount model (DDM) or capital asset pricing model (CAPM).
Cost of equity (DDM) = expected dividend in 1 year /current stock price + growth rate
Cost of equity (CAPM) = risk free rate + beta coefficient × market risk premium
Here Risk free rate assume 10 % beta assume 1.2 and market risk premium 5 %
10%+1.2*5% = 16 %
Cost of Debt =
Cost of debt is equal to the yield to maturity of the bonds. With the given data, we can assume that yield to maturity is 9 %. It is calculated using hit and trial method. We can also estimate it using MS Excel RATE function.
Hence cost of debt 9% (1-0.40) =5.4%
Now WACC =83.82%*16%+5.4%*16.18%
=13.41 %+8.73%
=22.14 %
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