Question

Hollydale's is a clothing store in East Park. It paid an annual dividend of ​$2.20 last year to its shareholders and plans to increase the dividend annually at 2.0​%. It has 500,000 shares outstanding. The shares currently sell for ​$27.89 per share. ​ Hollydale's has 10,000 semiannual bonds outstanding with a coupon rate of 11​%, a maturity of 24 ​years, and a par value of ​$1,000. The bonds are currently selling for ​$1,543.17 per bond. What is the adjusted WACC for ​Hollydale's if the corporate tax rate is 15​%?

Answer 1

As per Constant Dividend Growth Model,

Stock Price = D₀(1 + g)/(r - g)

r = 2.20(1.02)/27.89 + 0.02

r = 10.05%

Amount of Equity = 27.89(500,000) = $13,945,000

Calculating Cost of Debt,

Using TVM Calculation,

I = [FV = 1,000, PV = 1,543.17, T = 48, PMT = 55]

I = 6.50%

Amount of Debt = 1,543.17(10,000) = $15,431,700

Weight of Equity = 13,945,000/(13,945,000 + 15,431,700) = 0.4747

Weight of Debt = 1 - 0.4747 = 0.5253

WACC = 0.5253(1 - 0.15)(0.065) + 0.4747(0.1005)

WACC = 7.67%