Filer Manufacturing has 8.6 million shares of common stock outstanding. The curr

Question

Filer Manufacturing has 8.6 million shares of common stock outstanding. The current share price is $56, and the book value per share is $4. The company also has two bond issues outstanding. The first bond issue has a face value of $70.6 million and a coupon rate of 7.3 percent and sells for 108 percent of par. The second issue has a face value of $60.6 million and a coupon rate of 7.8 percent and sells for 109.5 percent of par. The first issue matures in 8 years, the second in 27 years. Suppose the company’s stock has a beta of 1.2. The risk-free rate is 3.4 percent, and the market risk premium is 7.3 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 35 percent. What is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Explanation / Answer

We will begin by finding the market value of each type of financing. We find: MVD1 = 70,600,000*(1.08)= $76,248,000 MVD2 = 60,600,000*(1.095)= $66,357,000 MVE = 8,600,000($56) = $481,600,000 And the total market value of the firm is: V = $76,248,000 +$66,357,000+ $481,600,000 V = $624,205,000 So, the market value weights of the company’s financing is: D1/V = $76,248,000/$624,205,000 = .1222 D2/V = $66,357,000/$624,205,000 = .1063 E/V = $481,600,000/$624,205,000 = .7715 b. For projects equally as risky as the firm itself, the WACC should be used as the discount rate. First, we can find the cost of equity using the CAPM. The cost of equity is: RE = .034 + 1.2(.073) RE = .1216 or 12.16% The cost of debt is the YTM of the bonds, so: P0 = $1080 = $36.50(PVIFA R%,16 ) + $1,000(PVIF R%,16 ) YTM = 6.025% P0 = $1095 = $39(PVIFA R%,54 ) + $1,000(PVIF R%,54 ) YTM = 7.011% And the after tax cost of debt is: RD = (1 – .35)(.06025) RD = .0392 or 3.92% RD = (1 – .35)(.07011) RD = .0456 or 4.56% Now, we can calculate the WACC as: WACC = .1222(.0392) + .1063(.0456) + .7715(.1216) WACC = .1035 or 10.35%

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