Question

TinTan Inc. is a appliance manufacturer in the USA. The company currently has 2,000,000 common shares outstanding. The shares currently sell for ​$12 each. The company paid an annual dividend of ​$3.00 last year to its shareholders and plans to increase the dividend annually at the rate of 4.0​%. TinTan Inc. also has 20,000 semiannual bonds outstanding with a coupon rate of 10​%, a maturity of 25 ​years, and a par value of ​$1,000. The bonds currently have a yield to maturity​ (YTM) of 12%. What is the weighted average cost of capital (WACC) for TinTan Inc. if the corporate tax rate is 20%?

When answering this problem enter your answer using percentage notation but do not use the % symbol and use two decimals (rounding). For example, if your answer is 0.10469 then enter 10.47; if your answer is 10% then enter 10.00

Answer 1

Cost of equity = (D0 * (1+g)) / P0 + g
= ($3 * (1 + 4%)) / $12 + 0.04
= $3.12 / $12 + 0.04
= 0.26 + 0.04
= 0.30 or 30%

After tax cost of debt = Before tax cost of debt * (1 - tax rate)
= 12% * (1 - 0.20)
= 9.60%

Current price of the bond can be calculated by using the following excel formula:
=PV(rate,nper,pmt,fv)
=PV(12%/2,25*2,-1000*10%/2,-1000)
= $842.38

Market value of equity = 2,000,000 * $12 = $24,000,000

Market value of debt = 20,000 * $842.38 = $16,847,627.87

Total value of firm = $24,000,000 + $16,847,627.87 = $40,847,627.87

Weight of debt = $16,847,627.87 / $40,847,627.87 = 0.41245

Weight of equity = $24,000,000 / $40,847,627.87 = 0.58755

WACC = (weight of debt * cost of debt) + (weight of equity * cost of equity)
= (0.41245 * 9.60%) + (0.58755 * 30%)
= 21.59%

WACC = 21.59