Question

Estimating the Weighted Average Cost of Capital Kellogg Company manufactures cereal and other convenience food under its many well-known brands such as Kellogg’s®, Keebler®, and Cheez-It®. The company, with over $13.5 billion in annual sales worldwide, partially finances its operation through the issuance of debt. At the beginning of its 2015 fiscal year, it had $6.5 billion in total debt. At the end of fiscal year 2015, its total debt had increased to $6.6 billion. Its fiscal 2015 interest expense was $227 million, and its assumed statutory tax rate was 37%. Kellogg has an estimated market beta of 0.50. Assume that the expected risk-free rate is 2.5% and the expected market premium is 5%. Kellogg’s stock closed at $72.27 on December 31, 2015. On that same date, the company had 420,315,589 shares issued, of which 70,291,514 shares were in treasury. a. What is Kellogg’s total market capitalization as of December 31, 2015? Enter answer in billions, rounding to one decimal place. $______ Answer billion b. Compute Kellogg’s WACC. Use your rounded answer above for computation. Round answer to one decimal place (ex: 0.0245 = 2.5%). Answer_____% Estimating Stock Value Using Dividend Discount Model with Constant Perpetuity Kellogg pays $2.00 in annual per share dividends to its common stockholders, and its recent stock price was $82.50. Assume that Kellogg’s cost of equity capital is 5.0%. a. Estimate Kellogg’s stock price using the dividend discount model with constant perpetuity. $_______Answer Estimating Stock Value Using Dividend Discount Model with Increasing Perpetuity Kellogg pays $2.00 in annual per share dividends to its common stockholders, and its recent stock price was $82.50. Assume that Kellogg’s cost of equity capital is 5.0%. Estimate Kellogg’s expected growth rate based on its recent stock price using the dividend discount model with increasing perpetuity. Do not round until your final answer. Round answer to one decimal place (ex: 0.0245 = 2.5%). Answer________% Estimating Intrinsic Share Value Using Dividend Discount Model Mattel, Inc. is expected to pay a $1.52 dividend per share annually. Estimate its intrinsic value per common share using the dividend discount model (DDM) under each of the following separate assumptions. (Assume that Mattel’s cost of equity capital is 8.0%.) Required a. The $1.52 dividend per share occurs at the end of each of the next three years, after which there are no additional dividend payments. Round answer to two decimal places. $ Answer b. The $1.52 dividend per share occurs at the end of each year in perpetuity. Round answers to two decimal places, if applicable. $ Answer c. The $1.52 dividend per share occurs at the end of each of the next three years, after which the dividends increase at a rate of 4% per year. Round answers to two decimal places. $_______Answer Estimating the Market’s Expected Growth Rate in Dividends Mattel, Inc. was trading at a price of $27.17 per common share at December 31, 2015. Using the Gordon growth model, estimate the market’s expected growth in dividends that is required to yield the $27.17 price per common share. Assume that the current dividend per share is $1.52 and is expected to grow thereafter, and that the cost of equity capital is 8.0%. (Hint: Use the equation for the dividend discount model with increasing perpetuity, at the top of page 12-19.) Round answer to one decimal place (ex: 0.0235 = 2.4%). Answer_______% Computing the Present Value of a Debt Security Compute the present value of a five-year bond with a face value of $1,000, a 10% annual coupon payment, and an 8% effective rate. Round answers to two decimal places. $_______Answer Estimating Cost of Equity Capital Assume that a company’s market beta equals 0.8, the risk-free rate is 5%, and the market return equals 8%. Compute the company’s cost of equity capital. Round answer to one decimal place (ex: 0.0245 = 2.5%) Answer______% Estimating the Implied Cost of Equity Capital Assume that a company’s beginning-of-period price is $10 per common share, its dividends are $0.25 per share, and its end-of-period price is $10.50 per common share. What is the company’s expected cost of equity capital? Round answer to one decimal place (ex: 0.0245 = 2.5%) Answer_______% Estimating the Implied End-of-Year Share Price Assume that a company’s beginning-of-period price is $15 per common share, its dividends are $1 per share, and its expected cost of equity capital is 10%. What is the expected end-of-period price per common share? Round answer to two decimal places. $_______Answer Estimating Cost of Debt Capital Assume that a company’s financial statements report that its average outstanding debt totals $1.6 billion, and its total interest expense equals $80 million. If its tax rate is 35%, compute its cost of debt capital. Round answer to two decimal places (ex: 0.02345 = 2.35%) Answer______% Estimating Weighted Average Cost of Capital Assume that a company has $1 billion in preferred stock and $3 billion in common stock. Also, it pays 6% dividends on preferred stock and its cost of equity capital is 7%. The company has no debt. Compute the company’s WACC. Round answers to two decimal places (ex: 0.02345 = 2.35%) Answer_____%

Answer 1

1. Kellogg’s total market capitalization = (420,315,589-70,291,514)*72.27 = $ 25296239900.25

2. Cost of equity = 2.5 + 0.5*5 = 2.5%

Cost of debt = 227/6600 = 3.44%

Weightage of equity = 25296239900.25/(25296239900.25+6600000000) = 79.31%

Kellogg's WACC = 3.44%*(1-0.37)*(1-79.31%) + 5%*79.31% = 4.4%

3. Kellogg's share price based on DDM = dividend/cost of equity = 2/0.05 = $ 40

4. Current stock price = $ 82.50

Based on Gordon Model;

82.50 = 2*(1+g)/(5%-g)

4.125 - 82.5g = 2 +2g

84.5g = 2.125

g= 2.52%

Mattel, Inc.

1. share price = 1.52/(1.08) + 1.52/(1.08)^2 + 1.52/(1.08)^3 = $ 3.92

2. Share price = 1.52/0.08 = $19

3. Share price = 1.52/(1.08) + 1.52/(1.08)^2 + 1.52/(1.08)^3 + 1.52*(1.04)/(0.04*1.08^3) =$35.30

4) 27.17 = 1.52*(1+g)/(8%-g)

2.1736 - 27.17g = 1.52 + 1.52g

28.69g = 0.6536

g = 2.28%

Present Value of a Debt Security

1. Value of 5 year bond = 100/(1.08)+100/(1.08)^2+100/(1.08)^3+100/(1.08)^4+1100/(1.08)^5 =$ 1079.85

Cost of Equity

1. Cost of Equity = 5%+0.8*(8%-5%) = 7.4%

2. Implied cost of equity = (10.5-10)+0.25/10 = 7.5%

3. Implied cost of equity = (Ending period share price-Beginning period shareprice+Dividend)/initial stock price

10% = (15-x +1)/x

0.1x = 16 -x

x = 16/1.1= $ 14.55

1. Cost of debt = 80*100/1600 = 5%

2. WACC = 6%*1/4 + 7%*3/4 = 6.75%