Erna Corp. has 8 million shares of common stock outstanding. The current share price is $73, and the book value per share is $7. Erna Corp. also has two bond issues outstanding. The first bond issue...

Erna Corp. has 8 million shares of common stock outstanding. The current share price is $73, and the
book value per share is $7. Erna Corp. also has two bond issues outstanding. The first bond issue has a
face value of $85 million, has a 7 percent coupon, and sells for 97 percent of par. The second issue has a
face value of $50 million, has an 8 percent coupon, and sells for 108 percent of par. The first issue
matures in 21 years, the second in 6 years.
A) Suppose the most recent dividend was $4.10 and the dividend growth rate is 6 percent. Assume that
the overall cost of debt is the weighted average of that implied by the two outstanding debt issues. Both
bonds make semiannual payments. The tax rate is 35 percent. What is the company's WACC? %
Solution:
Cost of equity –
Current share price, Po = $73
Current year dividend, Do = $4.10
Dividend growth rate, g = 6%
Cost of equity, Ke = Do*(1+g) / Po + g
Ke = 4.10*(1+6%) / 73 + 6%
Ke = 11.95%
No. of shares, E = 8 million
Total equity market value, MVe = E*Po = 8*73 = $584 million
Cost of debt –
21-yr maturity bond
Face value = $85 million
Current price of bond, A = 97% of par = 97%*85 = $82.45 million
Coupon rate = 7%
Frequency of payments = Semiannual
Years to maturity = 21 years
No. of periods, n = 21*2 = 42
Redemption value (assumed), R = $85 million
Semi-annual Coupon interest, P = 7% /2 * $85 million = $2.975 million
Yield to maturity = ytm
Current price of bond, A = P /(1+ytm)^1 + P /(1+ytm)^2...