Question

Dragula Industries most recently paid a dividend of $1.70 and dividends are expected to grow at a 6% annual rate indefinitely. The stock currently sells for $39 per share and there are 8 million shares outstanding. The company has 100,000 5% outstanding that are trading for par value and mature in 18 years. The coupon rate on the bonds is 5%. The average tax rate is 30%. What is the WACC?

Answer 1

Debt value = Quantity x Market price = 100000 x 1000 = 100,000,000

Equity value = Quantity x Share price = 8000000 x 39 = 312,000,000

Debt composition or Debt weight = 100,000,000 / (100,000,000+312,000,000) = 0.242718447

Equity composition or Equity weight = 312,000,000 / (100,000,000+312,000,000) = 0.757281553

Cost of equity = (Expected dividend / Stock price) + Growth rate

Cost of equity = (D1/P0) + g

Cost of equity = (1.7*(1+6%)/39) + 6%

Cost of equity = 10.62051%          

Cost of debt = 5%

WACC = Cost of equity x equity weight + Debt cost x Debt weight x (1-Tax)

WACC = 10.62051% x 0.757281553 + 5% x 0.242718447 x (1-30%) = 8.892231%

WACC = 8.89% (rounding to two decimals)

(Assuming debt face value or par value = $1,000)