Question

Asked Jun 11, 2019

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Inzaghi Company recently hired you as a consultant to estimate the company’s WACC. You have obtained the following information. (1) The company has noncallable bonds with $1,000 face value and coupon rate of 10% (paid semi-annually). The bonds mature in 4 years, and have current price of $1,140. (2) The company’s tax rate is 30%. (3) The current price of the company’s stock is $80.00 per share. Dividends are expected to grow at 5% indefinitely and the most recent dividend paid by the company was $2.75 per share. (4) The target capital structure of the company consists of 41.5% debt and the balance is common equity. (5) The company is not planning to issue any new common stock. What is Inzaghi Company’s WACC?

**** You must explain your approach in writing in four lines. No credit is given without explanation.**

** **

Step 1

WACC is the weighted average cost of capital. The same can be calculated as:

WACC = Wd x Kd x (1 - T) + We x Ke

where Wd = proportion of weight in capital structure = 41.5%;

We = proportion of equity in capital structure = 1 - Wd = 1 - 41.5% = 58.5%

T = Tax rate = 30%

Kd = pre tax cost of debt = yield of the bonds

and Ke = cost of equity.

Based on the information,

- We need to estimate the Kd and Ke first
- In order to find Kd, we will use RATE function in excel. Please note that coupons are paid semi annually. Hence, frequncy of payment in ayear is 2.
- Ke will be estimated using Gordan Growth Model (Or discounted cash flow approach using dividends).

Step 2

Please see

Please see the table on the white board for calculation of yield to maturity. The row highlighted in yellow is your answer. Figures in parenthesis mean negative values. All financials are in $. Adjacent cells in blue contain the formula in excel I have used to get the final output.

Pre tax cost of debt = Kd = ield to maturity = 6.01%

Step 3

The current price of the company’s stock, P0 = $80.00 per share. Dividends are expected to grow at g = 5% indefinitely and the most recent dividend paid by the company was D0 = $2.75 per shar...

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