Question

Erna Corp. has 9 million shares of common stock outstanding. The current share price is $88, and the book value per share is $7. Erna Corp. also has two bond issues outstanding. The first bond issue has a face value of $80 million, has a coupon rate of 5 percent, and sells for 98 percent of par. The second issue has a face value of $55 million, has a coupon rate of 6 percent, and sells for 106 percent of par. The first issue matures in 20 years, the second in 8 years.

Suppose the most recent dividend was $6.00 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 38 percent. What is the company’s WACC? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

  

WACC

%

Answer 1

Erna	Value	Weight	Cost
Equity	$ 792.00	85.3%	15.36%
Debt 1	$   78.40	8.4%	5.16%
Debt 2	$   58.30	6.3%	5.07%
Total	$ 928.70	WACC	13.57%

Value of equity = 88 x 9m = 792 million

Value of Debt 1 = 80 x 98% = 78.40m, Value of debt 2 = 55 x 106% = 58.30m

Weight = Value / Total Value

Cost of equity = D0 x (1 + g) / P + g = 6 x (1 + 8%) / 88 + 8% = 15.36%

Cost of debt can be calculated using I/Y function on a calculator

N = 20, PMT = 5, PV = -98, FV = 100 => Compute 5.16% for Debt 1

N = 8, PMT = 6, PV = -106, FV = 100 => Compute 5.07% for Debt 2

WACC = 85.3% x 15.36% + (8.4% x 5.16% + 6.3% x 5.07%) x (1 - 38%) = 13.57%