Erna Corp. has 6 million shares of common stock outstanding. The current share p
ID: 2646388 • Letter: E
Question
Erna Corp. has 6 million shares of common stock outstanding. The current share price is $78, and the book value per share is $5. Erna Corp. also has two bond issues outstanding. The first bond issue has a face value of $65 million, has a coupon rate of 7 percent, and sells for 98 percent of par. The second issue has a face value of $35 million, has a coupon rate of 8 percent, and sells for 106 percent of par. The first issue matures in 22 years, the second in 5 years.
Suppose the most recent dividend was $5.00 and the dividend growth rate is 8 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 30 percent. What is the company
Erna Corp. has 6 million shares of common stock outstanding. The current share price is $78, and the book value per share is $5. Erna Corp. also has two bond issues outstanding. The first bond issue has a face value of $65 million, has a coupon rate of 7 percent, and sells for 98 percent of par. The second issue has a face value of $35 million, has a coupon rate of 8 percent, and sells for 106 percent of par. The first issue matures in 22 years, the second in 5 years.
Suppose the most recent dividend was $5.00 and the dividend growth rate is 8 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 30 percent. What is the company
Explanation / Answer
Step 1 :
Cost of Common Stock = Expected Dividend/Stock Price + growth rate
Cost of Common Stock = 5*(1+8%)/78 + 8%
Cost of Common Stock = 14.92%
Before Tax Cost of Debt of 1st Bond= rate(nper,pmt,pv,fv) *2
nper = 22*2 = 44
pmt = 7%*1000*1/2 = 35
pv = 98%*1000 = 980
fv = 1000
Before Tax Cost of Debt of 1st Bond = rate(44,35,-980,1000) * 2
Before Tax Cost of Debt of 1st Bond = 7.18 %
After Tax Cost of Debt of 1st Bond = 7.18*(1-30%)
After Tax Cost of Debt of 1st Bond = 5.03%
Before Tax Cost of Debt of 2nd Bond= rate(nper,pmt,pv,fv) *2
nper = 5*2 = 10
pmt = 8%*1000*1/2 = 40
pv = 106%*1000 = 1060
fv = 1000
Before Tax Cost of Debt of 2nd Bond = rate(10,40,-1060,1000) * 2
Before Tax Cost of Debt of 2nd Bond = 6,57%
After Tax Cost of Debt of 2nd Bond = 6.57*(1-30%)
After Tax Cost of Debt of 2nd Bond = 4.60%
Step 2 :
Market Value of Common Stock = 6Milion * 78 = $ 468 Million
Market value of 1st Bond = 65 *98% = 63.70 Million
Market Value of 2nd Bond = 35*106%= $ 37.10 Million
Total Market Value = $ 568.80 Million
Weight of Common Stock = 468/568.80
Weight of 1st Bond = 63.70/568.80
Weight of 2nd Bond = 37.10/568.80
Step3:
WACC = Weight of Common Stock* Cost of Common Stock + Weight of 1st Bond * After Tax cost of Debt of 1st bond+ Weight of 2nd Bond* After Tax cost of Debt of 2nd bond
WACC = 468/568.80*14.92 + 63.70/568.80*5.03 + 37.10/568.80*4.60
WACC = 13.14 %