Bonaime, Inc., has 7.1 million shares of common stock outstanding. The current s
ID: 2794518 • Letter: B
Question
Bonaime, Inc., has 7.1 million shares of common stock outstanding. The current share price is $62.10, and the book value per share is $5.10. The company also has two bond issues outstanding. The first bond issue has a face value of $71.1 million, a coupon rate of 7.1 percent, and sells for 92.5 percent of par. The second issue has a face value of $36.1 million, a coupon rate of 7.6 percent, and sells for 91.5 percent of par. The first issue matures in 21 years, the second in 13 years. The most recent dividend was $3.40 and the dividend growth rate is 7 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 34 percent.
What is the company’s WACC?
Explanation / Answer
Answer)
First, we will find the cost of equity for the company.
The information provided allows us to solve for the cost of equity usingthe dividend growth model, so:RE= [$3.40(1.07)/$62.10] + .07
RE= .1286, or 12.86%
Next, we need to find the YTM on both bond issues.
Doing so, we find:P1= $925 = $35.50(PVIFAR%,42) + $1,000(PVIFR%,42)R= 3.917%
YTM = 3.917% × 2
YTM = 7.83%
P2= $915 = $38.00(PVIFAR%,26) + $1,000(PVIFR%,26)
R= 4.352%
YTM = 4.352% × 2
YTM = 8.70%
To find the weighted average aftertax cost of debt, we need the weight of each bond as a percentage of the total debt.
Wefind:
xD1= .925($71,100,000) / $98,799,000
xD1= .6657
xD2= .915($36,100,000) / $98,799,000
xD2= .3343
Now we can multiply the weighted average cost of debt times one minus the tax rate to find the weighted average aftertaxcost of debt. This gives us:
RD= (1 – .34)[(.6657)(.0783) + (.3343)(.0870)]RD= .0536, or 5.36%
The market value of equity is the share price times the number of shares, so:
MVE= 7,100,000($62.10)
MVE= $440,910,000
Using the relationship that the total market value of debt is the price quote times the par value of the bond, we find themarket value of debt is:
MVD= .925($71,100,000) + .915($36,100,000)
MVD= $98,799,000T
his makes the total market value of the company:V = $440,910,000 + 98,799,000V = $539,709,000
And the market value weights of equity and debt are:E/V = $440,910,000 / $539,709,000E/V = .8169D/V = 1 E/VD/V = .1831
Using these weights and the costs of equity and debt we calculated earlier, the WACC is:WACC = .8169(.1286) + .1831(.0536)WACC = .1149, or 11.49%