Filer Manufacturing has 4 million shares of common stock outstanding. The curren

Question

Filer Manufacturing has 4 million shares of common stock outstanding. The current share price is $70, and the book value per share is $5. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $60 million, has a 5 percent coupon, and sells for 95 percent of par. The second issue has a face value of $40 million, has a 6 percent coupon, and sells for 104 percent of par. The first issue matures in 20 years, the second in 4 years. The most recent dividend was $4.2 and the dividend growth rate is 4 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?

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Explanation / Answer

Market value of equity = 4 million * 70 = $ 280 million

Market value of debt issue 1 = 60 * 0.95 = $ 57 million

Market value of debt issue 2 = 40 * 1.04 = $ 41.6 million

Total firm value = 280 + 57 + 41.6 = $ 378.6 million

Market weight of equity = 280 / 378.6 = 73.96%

Market weight of debt issue 1 = 57 / 378.6 = 15.06%

Market weight of debt issue 2 = 41.6 / 378.6 = 10.99%

Cost of equity = next year dividend / stock price + growth rate = 4.2 * 1.04 / 70 + 4% = 10.24%

Pre-tax cost of debt issue 1 can be calculated in Excel as =RATE(20*2,-50/2,950,-1000)*2. This is equal to 5.41%

After-tax cost of debt issue 1 = 5.41% * (1-38%) = 3.36%

Pre-tax cost of debt issue 2 can be calculated in Excel as =RATE(4*2,-60/2,1040,-1000)*2. This is equal to 4.89%

After-tax cost of debt issue 2 = 4.89% * (1-38%) = 3.03%

WACC = cost of equity * weight of equity + cost of debt issue 1 * weight of debt issue 1 + cost of debt issue 2 * weight of debt issue 2 = 0.7396 * 10.24% + 0.1506 * 3.36% + 0.1099 * 3.03% = 8.41%

Answer: WACC = 8.41%

Hope this helped ! Let me know in case of any queries.

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