Dinklage Corp. has 6 million shares of common stock outstanding. The current sha
ID: 2793278 • Letter: D
Question
Dinklage Corp. has 6 million shares of common stock outstanding. The current share price is $72, and the book value per share is $7. The company also has two bond issues outstanding. The first bond issue has a face value of $70 million, a coupon rate of 7 percent, and sells for 97 percent of par. The second issue has a face value of $50 million, a coupon rate of 8 percent, and sells for 106 percent of par. The first issue matures in 22 years, the second in 6 years. Suppose the most recent dividend was $4.40 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 35 percent. What is the company’s WACC?
Explanation / Answer
Market Value of equity = No. of shares x Share Price = 72 x 6 = 432 million
Market Value of first bond issue = Face Value x % Par Value = 70 x 97% = 67.9 million
Market Value of second bond issue = 50 x 106% = 53 million
=> Total Value = 432 + 67.9 + 53 = $552.9 million
Weight of equity, we = 432 / 552.9 = 78.1%
Weight of first bond issue, wd1 = 12.3%
Weight of second issue, wd2 = 9.6%
Using DCF, cost of equity, ke = D0 x (1 + g) / P + g = 4.4 x (1 + 6%) / 72 + 6% = 12.48%
Cost of debt can be calculated using I/Y function on a calculator
For first issue, N = 22 x 2 = 44, PMT = 7% x 100 / 2 = 3.5, PV = -97, FV = 100 => Compute I/Y = 3.64% (semi-annual)
Cost of first bond issue, kd1 = 3.64% x 2 = 7.28%
For second issue, N = 6 x 2 = 12, PMT = 8% x 100 / 2 = 4, PV = -106, FV = 100 => Compute I/Y = 3.38% (semi-annual)
Cost of second bond issue, kd2 = 3.38% x 2 = 6.77%
WACC = we x ke + (wd1 x kd1 + wd2 x kd2) x (1 - tax)
= 78.1% x 12.48% + (12.3% x 7.28% + 9.6% x 6.77%) x (1 - 35%)
= 10.75%
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