Reference no: EM133114397
Question 1
D & D Communications Corporation was seeking advice about establishing a program to repurchase some of its outstanding common stock. Throughout most of 2021, DD's stock had been a sluggish performer in an otherwise buoyant market, and management sensed a growing restlessness on the part of shareholders. At a recent meeting of the board of directors, discussions had centered on repurchasing some of the company's stock as a means to enhance shareholder value, and optimizing the capital structure. One long-time director had pushed hard to finance the repurchase by increasing DD's debt financing, and argued that this action would send a bold signal to the market about the future prospects of the firm. To be effective as a signa1, he suggested that the company would need to approximately double its current book value debt-to-equity ratio of 45%. This would cause their current single "A" bond rating and to get downgraded to "BBB". He estimated that such action would require the firm to issue approximately $2 billion in additional debt.
Financial Highlights 2020:(all figures in millions except for EPS/Share Price)
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2020
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Operating Income (EBIT)
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$1,402 M
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Interest Expense
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(181)
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EBIT - I = Taxable Income
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1,221
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Minus Taxes (40%)
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(488)
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Net Income
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733
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Shares Outstanding
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681
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EPS
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$1.08
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Share Price
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$27.75
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Selected S&P Current Debt Obligation Yields:
AAA (Gov't of Cda 10 year): 5.7%
A: 6.10%
BBB: 6.40%
Data on D&D Publicly Traded Debt:
Credit Rating: A
Yield: 6.10%
Book value (in millions): $3,444.00
Data on D&D Publicly Traded Equity:
Current Price: $27.75
Current Beta: 1.0
Shares Outstanding (in millions): 681.0M
Book value (in millions): $7,602.0M
Market Risk premium: 7.0%
Other Data:
Target D/E: 28.81%
Corporate Tax Rate: 40.0%
1.b) Estimate D&D's WACC after the debt issuance and subsequent share repurchase at the current market price (to two decimal places) and bond rating downgrade to BBB. Assume shares are repurchased at the current share price.
Hint: recall that the Beta unleveraging/leveraging formulas:
βunlevered = βlevered / [1+D/E] ; βlevered = βunlevered[1+D/E]: