Erna Corp. has 8 million shares of common stock outstanding. The current share p

Question

Erna Corp. has 8 million shares of common stock outstanding. The current share price is $73, and the book value per share is $7. Erna Corp. also has two bond issues outstanding. The first bond issue has a face value of $85 million, has a 7 percent coupon, and sells for 97 percent of par. The second issue has a face value of $50 million, has an 8 percent coupon, and sells for 108 percent of par. The first issue matures in 21 years, the second in 6 years.

Suppose the most recent dividend was $4.10 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

WACC = Weight Of Equity * Cost Of Equity + Weight Of Debt * Cost of debt( 1 -tax rate)

Cost of equity = D0(1+G)/P + G = 4.1(1.06)/73 + 6 = 11.95%

Calculation of weights according to market values

Market Value of equity = 73 * 8 million = 584 million

Market Value of Debt 1 = 85 Million * 97% = 82.45 Million

Market Value of Debt 2 = 50 million * 108% = 54 million

Total Capital = 584 + 82.45 + 54 = 720.45 million

WACC = 584/720.45 * 11.95% + 82.45/720.45 * 7%( 1 - 0.35) + 54/720.45 * 8%( 1 - 0.35) = 10.597%

Related Questions

Navigate

• Browse (All)
• Browse E
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.