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.
bullet•
The risk-free rate is
44%.
bullet•
The expected return on the market portfolio is
9.259.25%.
bullet•
The corporate tax rate is
3838%.
bullet•
The face value of Tootsie Roll's outstanding bonds is
$2 comma 4002,400
million.
bullet•
The coupon rate on Tootsie Roll's bonds is
5.55.5%.
Assume that the bonds pay annual coupons.
bullet•
The yield to maturity on Tootsie Roll's bonds is
77%.
bullet•
Tootsie Roll's bonds mature in
77
years.
bullet•
Tootsie Roll has
1 comma 6501,650
million common shares outstanding.
bullet•
The market price of Tootsie Roll's common shares is
$6.056.05.
bullet•
Tootsie Roll's Beta is
0.70.7.
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?
| a) | After tax cost of debt = YTM*(1-t) = 7%*(1-38%) = | 4.34% |
| b) | Cost of equity per CAPM = rf+beta*(rm-rf), where | |
| rf = risk free rate and rm = expected return on | ||
| market portfolio. | ||
| = 4%+0.7*(9.25%-4%) = | 7.68% | |
| c) | MV of long term debt = 2400/1.07^7+2400*5.5%*(1.07^7-1)/(0.07*1.07^7) = | $ 2,205.99 |
| d) | MV of equity = 1650*6.05 = | $ 9,982.50 |
| MV of debt | $ 2,205.99 | |
| Total market value | $ 12,188.49 | |
| Capital structure weight for equity = 9982.50/12188.49 = | 81.90% | |
| Capital structure weight for debt = 2205.99/12188.49 = | 18.10% | |
| e) | WACC = Cost of debt*Weight of debt+Cost of equity*Weight of equity = 7.68%*81.90%+4.34%*18.10% = | 7.08% |
Get Answers For Free
Most questions answered within 1 hours.