Question

Over the last twenty years there has been considerable consolidation in the confectionary business​ (e.g., the acquisition of Rowntree PLC by Nestle SA in 1988 and Cadbury by Kraft in​ 2010). You have a suspicion that a large food manufacturer might try to buy Tootsie Roll. You want to calculate a DCF valuation for Tootsie Roll. The first step in your valuation is to calculate Tootsie​ Roll's weighted average cost of capital. Using the data provided​ below, answer the questions that follow and calculate Tootsie​ Roll's WACC.

The​ risk-free rate is 4.25​%.

The expected return on the market portfolio is 9.25​%.

The corporate tax rate is 42​%.

The face value of Tootsie​ Roll's outstanding bonds is ​$2,500 million.

The coupon rate on Tootsie​ Roll's bonds is

4​%. Assume that the bonds pay annual coupons.

The yield to maturity on Tootsie​ Roll's bonds is 7​%.

Tootsie​ Roll's bonds mature in 7 years.

Tootsie Roll has 1,600 million common shares outstanding.

The market price of Tootsie​ Roll's common shares is ​$6.15.

Tootsie​ Roll's Beta is 0.8.

a.  What is Tootsie​ Roll's after-tax cost of​ debt?

b.  What is Tootsie​ Roll's cost of​ equity?

c.  What is the market value of​ long-term debt?

d.  What is the capital structure weight for​ equity?

e.  What is Tootsie​ Roll's WACC?

Answer 1