Filer Manufacturing has 5 million shares of common stock outstanding. The curren

Question

Filer Manufacturing has 5 million shares of common stock outstanding. The current share price is $77, and the book value per share is $8. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $60 million, has a 6 percent coupon, and sells for 97 percent of par. The second issue has a face value of $30 million, has a 7 percent coupon, and sells for 105 percent of par. The first issue matures in 21 years, the second in 4 years.

The most recent dividend was $4.9 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 40 percent.

The most recent dividend was $4.9 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 40 percent.

Explanation / Answer

Cost of debt =

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

        K= 21x2           
970 = [(6*1000/(100*2))/(1 + YTM1/200)^k]     +   1000/(1 + YTM1/200)^21x2
        k=1

YTM1 = 6.258%

                   K =Nx2          

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

   K= 4x2           
1050= [(7*1000/(100*2))/(1 + YTM2/200)^k]     +   1000/(1 + YTM2/200)^4x2
       k=1

YTM2 = 5.5877%

Before tax cost of debt YTM = YTM1*(MV bond 1)/(MV bond 1+ MV bond 2) + YTM2*(MV bond 2)/(MV bond 1+ MV bond 2)

=6.258*(60*.97)/(60*0.97 + 30*1.05) + 5.5877(30*1.05)/( 60*0.97 + 30*1.05) = 6.02261%

Cost of equity:

Price = recent dividend* ( 1 + growth rate )/( cost of equity - growth rate)

77 = 4.9 * (1 + .06)/(cost of equity - 0.06)

= 12.745%

MV of debt = ( 60*0.97 + 30*1.05) = 89.7

MV of equity = 77*5 = 385

WACC = wd(rd)(1 – T) + wc(rs) = 6.02261*89.7*(1-0.40)/(385+89.7)+12.745*385/(385+89.7) = 11.0195%

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