Masterson, Inc., has 3.6 million shares of common stock outstanding. The current share price is $85.50, and the book value per share is $9.25. The company also has two bond issues outstanding. The first bond issue has a face value of $73 million, a coupon rate of 5.3 percent, and sells for 95.7 percent of par. The second issue has a face value of $45 million, a coupon rate of 5.9 percent, and sells for 104.9 percent of par. The first issue matures in 23 years, the second in 11 years. The most recent dividend was $4.04 and the dividend growth rate is 4.3 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 23 percent. 1. What is the company's cost of equity?
2. What is the company's aftertax cost of debt?
3. What is the company's weight of equity?
4. What is the company's weight of debt?
5. What is the company's WACC?

1. 9.03 %

2. 7.56 %

3. 72.45 %

4. 27.55 %

5. 8.63 %

Explanation:

Cost of equity is the return that is required by holders of Common Stocks

Cost of equity = Recent year`s dividend / Current Market Price + Expected Growth Rate

                       = $4.04 / $85.50 + 0.043

                       = 0.0903 or 9.03 %

1st bond issue

PV = $69,861,000

Pmt = ($73,000,000 × 5.30%) ÷ 2 = - $1,934,500

p/y = 2

n  = 23 × 2 = 46

Fv = 0

i = ?

Cost of the 1st Bond Issue, i is : 2.1571 %

After tax cost = 2.1571 % × 77 %

                      = 1.66%

2nd Bond Issue

PV = $47,205,000

Pmt = ($45,000,000 × 5.90%) ÷ 2 = - $1,327,500

p/y = 2

n  = 11 × 2 = 22

Fv = 0

i = ?

Cost of the 2nd Bond Issue, i is : 7,6681 %

After tax cost = 7,6681 % × 77 %

                      = 5.90%

Total Cost of Debt = 1.66% + 5.90%

                               = 7.56 %

Market Values :

Market Value of Equity = 3,600,000 shares × $85.50

                                      = $307,800,000

Market Value of Bonds

1st Issues  =  $69,861,000

2nd Issue  = $47,205,000

Total          = $117,066,000

Weight of equity = Market Value of Equity ÷ Total Market Value

                            = $307,800,000 ÷ ($307,800,000 + $117,066,000)

                            = 72.45 %

Weight of debt    = Market Value of Bonds ÷ Total Market Value

                            = $117,066,000 ÷ ($307,800,000 + $117,066,000)

                            = 27.55 %

WACC = Weighted Cost of Debt + Weighted Cost of Equity

           = 27.55 % × 7.56 % + 72.45 % ×  9.03 %

           = 8.63 %