Massive Inc shares have a market capitalisation of $55 billion. The company just paid a dividend of $0.35 per share and each share trades for $35. The growth rate in dividends is expected to be 6.5% per year. Also, Massive has $20 billion of debt that trades with a yield to maturity of 7%. If the firm's tax rate is 30%, compute the WACC.

Question

Quizplus · Accepted Answer

Calculate the cost of equity:

Dividend paid = $0.35
Current market price = $35
Dividend growth rate = 6.5%

Dividend expected in the next year = $0.35 x (1 + 6.5%) = $0.37225
Expected price of stock in the next year = $35 x (1 + 6.5%) = $37.2975

Cost of equity using the dividend discount model:

Cost of equity = (expected dividend / current market price) + expected growth rate

Cost of equity = ($0.37225 / $35) + 6.5% = 7.66%

Calculate the cost of debt:

Debt yield to maturity = 7%
Tax rate = 30%

After-tax cost of debt = debt yield to maturity x (1 - tax rate)

After-tax cost of debt = 7% x (1 - 30%) = 4.9%

Calculate the weighted average cost of capital:

Weight of equity = market cap / (market cap + debt)
Weight of equity = $55 billion / ($55 billion + $20 billion) = 0.7333

Weight of debt = debt / (market cap + debt)
Weight of debt = $20 billion / ($55 billion + $20 billion) = 0.2667

WACC = (cost of equity x weight of equity) + (after-tax cost of debt x weight of debt)

WACC = (7.66% x 0.7333) + (4.9% x 0.2667) = 6.85%

Massive Inc Shares Have a Market Capitalisation of $55 Billion