Question

Over the last twenty years there has been considerable consolidation in the confectionary business​ (e.g., the acquisition of Rowntree PLC by Nestle SA in 1988 and Cadbury by Kraft in​ 2010). You have a suspicion that a large food manufacturer might try to buy Tootsie Roll. You want to calculate a DCF valuation for Tootsie Roll. The first step in your valuation is to calculate Tootsie​ Roll's weighted average cost of capital. Using the data provided​ below, answer the questions that follow and calculate Tootsie​ Roll's WACC.

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The​ risk-free rate is

4.54.5​%.

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The expected return on the market portfolio is

8.58.5​%.

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The corporate tax rate is

3535​%.

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The face value of Tootsie​ Roll's outstanding bonds is

​$2 comma 4502,450

million.  

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The coupon rate on Tootsie​ Roll's bonds is

66​%.

Assume that the bonds pay annual coupons.

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The yield to maturity on Tootsie​ Roll's bonds is

77​%.

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Tootsie​ Roll's bonds mature in

1111

years.

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Tootsie Roll has

1 comma 7001,700

million common shares outstanding.

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The market price of Tootsie​ Roll's common shares is

​$6.256.25.

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Tootsie​ Roll's Beta is

0.70.7.

a.  What is Tootsie​ Roll's after-tax cost of​ debt?

b.  What is Tootsie​ Roll's cost of​ equity?

c.  What is the market value of​ long-term debt?

d.  What is the capital structure weight for​ equity?

e.  What is Tootsie​ Roll's WACC?

Answer 1

a.Tootsies Rolls after-tax cost of debt

=7%*(1-35%)
= 4.55%

b. Tootsie's Rolls cost of equity

=4.5%+0.7*(8.5%-4.5%)

=4.5%+2.8%

=7.3%

c.Market value of long-term debt

=(4502*6%)*((1-(1+7%)^(-11))/7%)+4502/(1+7%)^11

=$4,164.41 mln

d.Capital structure weight for equity

=(7001*6.25)/(7001*6.25+4164.41)

=0.9131 = 91.31%

e. WACC

=91.31%*7.3%+(1-91.31%)*4.55%

=7.06%