Filer Manufacturing has 8.8 million shares of common stock outstanding. The curr

Question

Filer Manufacturing has 8.8 million shares of common stock outstanding. The current share price is $58, and the book value per share is $3. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $71.0 million and a coupon rate of 7.5 percent and sells for 107.8 percent of par. The second issue has a face value of $61.0 million and a coupon rate of 8.0 percent and sells for 109.9 percent of par. The first issue matures in 7 years, the second in 28 years.

Suppose the company’s stock has a beta of 1.1. The risk-free rate is 3.6 percent, and the market risk premium is 7.5 percent. Assume that the overall cost of debt is the weighted average implied by the two outstanding debt issues. Both bonds make semiannual payments. The tax rate is 34 percent. What is the company’s WACC?

Filer Manufacturing has 8.8 million shares of common stock outstanding. The current share price is $58, and the book value per share is $3. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $71.0 million and a coupon rate of 7.5 percent and sells for 107.8 percent of par. The second issue has a face value of $61.0 million and a coupon rate of 8.0 percent and sells for 109.9 percent of par. The first issue matures in 7 years, the second in 28 years.

Suppose the company’s stock has a beta of 1.1. The risk-free rate is 3.6 percent, and the market risk premium is 7.5 percent. Assume that the overall cost of debt is the weighted average implied by the two outstanding debt issues. Both bonds make semiannual payments. The tax rate is 34 percent. What is the company’s WACC?

Explanation / Answer

expected return on equtiy = risk-free rate + beta * (market risk premium)

= 3.6 + 1.1 * 7.5 =11.85%

K =Nx2         
BOND PRICE= [(Semi-annual Coupon)/(1 + YTM1/2)^k]     +   Par value/(1 + YTM1/2)^(Nx2)
                   k=1

                    K= 7x2          
1078 = [(7.5*1000/(100*2))/(1 + YTM1/200)^k]     +   1000/(1 + YTM1/200)^7x2
                   k=1

YTM1 = 6.1136%

K =Nx2         
BOND PRICE= [(Semi-annual Coupon)/(1 + YTM2/2)^k]     +   Par value/(1 + YTM2/2)^(Nx2)
                   k=1

K= 28x2           
1099 = [(8*1000/(100*2))/(1 + YTM2/200)^k]     +   1000/(1 + YTM2/200)^28x2
                   k=1

YTM2 = 7.175%

Overall YTM = market value of debt1* YTM1/(Market vaue of debt 1 &2) + Market value of debt2 *YTM2/(Market vaue of debt 1 &2)

  = 6.1136*71*1.078/(71*1.078 + 61*1.099) + 7.175*61*1.099/(71*1.078 + 61*1.099)

= 6.609%

Market value of debt = 71*1.078 + 61*1.099 = 143.577m

Market value of equity = no. of shares*price = 8.8*58 = 510.4m

WACC = overall YTM* ( 1 - tax rate)*Market value of debt /Market value of debt & equity +

cost of equity*Market value of equity/Market value of debt & equity

= 6.609*(1-0.34)*143.577/(143.577+510.4)+11.85*510.4/(143.577+510.4) = 10.206%

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