Question

Comida corp. is a grocery store located in the midwest. It paid an annual dividend of ​$2.00 last year to its shareholders and plans to increase the dividend annually at 2.0% forever. It has 500,000 shares outstanding. The shares currently sell for ​$23 per share. Comida Corp. has 10,000 semiannual bonds outstanding with a coupon rate of 8%, a maturity of 18 ​years, and a par value of $1,000. The bonds currently have a yield to maturity​ (YTM) of 6​% per bond. What is the adjusted WACC for Comida Corp. if the corporate tax rate is 25​%?

Answer 1

As per Constant Dividend Growth Model,

Stock Price = D₀(1 + g)/(r - g)

So,

r = 2(1.02)/23 + 0.02

r = 10.87%

Cost of Equity = 10.87%

Value of Equity = 23(500,000) = $11,500,000

Calculating Present Value of Bond,

Using TVM Calculation,

PV = [FV = 1,000, T = 26, PMT = 40, I = 0.06/2]

PV = $1,218.32

Cost of Debt = 6%

Amount of Debt = 1,218.32(10,000) = $12,183,200

Weight of Equity = 11,500,000/(11,500,000 + 12,183,200) = 0.4856

Weight of Debt = 1 - 0.4856 = 0.5144

So,

WACC = 0.5144(1 - 0.25)(0.06) + 0.4856(0.1087)

WACC = 7.59%