Problem 13-9 Calculating the WACC Filer Manufacturing has 8.0 million shares of
ID: 2785857 • Letter: P
Question
Problem 13-9 Calculating the WACC Filer Manufacturing has 8.0 million shares of common stock outstanding. The current share price is $50, 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 $69.4 milion and a coupon rate of 6.7 percent and sells for 108.6 percent of par. The second issue has a face value of $59.4 million and a coupon rate of 7.2 percent and sells for 108.3 percent of par. The first issue matures in 9 years, the second in 26 years. share is s5. Filer Manufacturgn ate of 6.7percent and Suppose the company's stock has a beta of 1.3. The risk-free rate is 2.8 percent, and the market risk premium is 6.7 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) WACC 0Explanation / Answer
Market value of equity = 8 million *$50 = $ 400 million
Market value of first issue of debt = $69.4 Million * 108.6% = $ 75.3684 million
Market value of second issue of debt = $59.4 Million * 108.3% = $64.3302 million
Total Market value of debt = $ 75.3684 million +$64.3302 million =$139.6986 million
Total value of firm = Market value of equity + Market value of first issue of debt + Market value of second issue of debt
= $ 400 million +$ 75.3684 million + $64.3302 million
= $539.6986 million
We need to find the YTM on both bond issues
Before tax cost of debt is bond’s yield; we have following formula for calculation of bond’s yield
Bond price P0 = C* [1- 1/ (1+i) ^n] /i + M / (1+i) ^n
Where
Price of the bond P0 = $ 75.3684 million
C = coupon payment = 6.7%/2 of $69.4 million = $2,324,900 semiannual coupon
n = number of payments = 9 years *2 = 18
i = interest rate, or yield to maturity =?
M = value at maturity, or par value = $69.4 million
Now we have,
$ 75.3684 million = $2,324,900 * [1 – 1 / (1+i) ^18] /i + $69.4 million / (1+i) ^18
By trial and error method we got the value of I = 2.74%
Or YTM of first issue = 2.74 *2 = 5.469%
After tax cost of debt = 5.469% *(1-0.4) =3.29%
Similarly we can calculate YTM of second issue, now we have
$64.3302 million = $2,138,400* [1 – 1 / (1+i) ^52] /i + $59.4 million / (1+i) ^52
By trial and error method we got the value of I = 3.27%
Or YTM of second issue = 3.27 *2 = 6.53%
After tax cost of debt = 6.53% *(1-0.4) = 3.92%
Overall cost of debt is the weighted average implied by the two outstanding debt issues
Overall cost of debt = ($75.3684 /$139.6986) * 3.29% + ($64.3302 /$139.6986) * 3.92%
= 3.58%
re= the firm's cost of equity = risk free rate (rf) + of stock * risk premium on the market
= 2.8% + 1.3 *6.7% = 11.51%
Weighted Average Cost of Capital (WACC)
WACC = [E/ (E+D)] * re + [D/ (E+D)] * rd
Where, re is the cost of equity
rd is the after tax cost of debt
E is the value of common equity
D is the value of debt
WACC = ($ 400 million / $539.6986 million) * 11.51% + ($139.6986 million / $539.6986 million) * 3.58%
= 8.53% + 0.93%
=9.46%
Therefore Weighted Average Cost of Capital (WACC) of firm is 9.46%