Filer Manufacturing has 9.0 million shares of common stock outstanding. The curr

Question

Filer Manufacturing has 9.0 million shares of common stock outstanding. The current share price is $60, 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 $71.4 million and a coupon rate of 7.7 percent and sells for 107.6 percent of par. The second issue has a face value of $61.4 million and a coupon rate of 8.2 percent and sells for 110.3 percent of par. The first issue matures in 9 years, the second in 26 years. Suppose the company’s stock has a beta of 1.3. The risk-free rate is 3.8 percent, and the market risk premium is 7.7 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 40 percent. What is the company’s WACC? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16))

Explanation / Answer

Market value of equity = Shares outstanding x Current Share Price
=> 9,000,000 x $60 = $540,000,000

Market value of first bond = $71,400,000 x 1.076 = $76,826,400
Market value of second bond = $61,400,000 x 1.103 = $67,724,200

Total value of firm = $540,000,000 + $76,826,400 + $67,724,200 = $684,550,600

Weight of equity = $540,000,000/$684,550,600 = 0.788838692 or 78.88%
Weight of first bond = $76,826,400/$684,550,600 = 0.112228957 or 11.22%
Weight of second bond = $67,724,200/$684,550,600 = 0.098932351 or 9.89%

Cost of equity: It is required rate of return as per CAPM model
Formula: Rj=Rf + Beta (Rm-Rf)
=> Cost of equity = 3.8 + 1.3*(7.7) = 13.81%

Cost of bond: It is the after-tax YTM of the bond.
Formula: Bond Value = C/2 {[1-(1+(YTM/2))-2t/(YTM/2)] + [F / (1+ (YTM/2))2t]

YTM of first bond:
B0 = Market value of the bond price => $76,826,400
C = the annual coupon payment, => $71,400,000 x 7.7% = $5,497,800
F = the face value of the bond, => $71,400,000
YTM = the yield to maturity on the bond, and
t = the number of years remaining until maturity => 9

$76,826,400 = $5,497,800/2 {[1-(1+(YTM/2))-18/(YTM/2)] + [$71,400,000 / (1+ (YTM/2))18] = 6.57%

After-tax YTM = YTM x (1-tax rate) => 6.57% x (1-0.40) = 3.942%

YTM of second bond:
B0 = Market value of the bond price => $67,724,200
C = the annual coupon payment, => $61,400,000 x 8.2% = $5,034,800
F = the face value of the bond, => $61,400,000
YTM = the yield to maturity on the bond, and
t = the number of years remaining until maturity => 26

$67,724,200 = $5,034,800/2 {[1-(1+(YTM/2))-52/(YTM/2)] + [$61,400,000 / (1+ (YTM/2))52] = 7.31%

After-tax YTM = YTM x (1-tax rate) => 6.57% x (1-0.40) = 4.386%

WACC = (13.81% x 78.88%) + (3.942% x 11.22%) + (4.386% x 9.89%) = 11.77%

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