Question

Consider the following information for Evenflow Power Co.,

Debt: 2,500 bonds that each year pay 8 percent of par value as an annual coupon, have a $1,000 par value, and a yield to maturity of 7.59 percent compounded annually. The bonds have 18yrs to maturity and currently sell for 104 percent of par (face) value.

Common stock: 62,500 shares outstanding, selling for $57 per share; the beta is 1.1.

Preferred stock: 9,000 preferred shares that pay a dividend of 7 percent annually on $100 par value and currently sell for $105 per share.

Market: 9 percent market risk premium and 7 percent risk-free rate.

Assume the company's tax rate is 32 percent.

Required: Find the WACC. (Do not round your intermediate calculations.)

Answer 1

Market Value of Debt = Par Value x 104% x No. of bonds = $1,000 x 104% x 2,500 = $2,600,000

Market Value of Common Stock = Selling Price x No. of Shares = $57 x 62,500 = $3,562,500

Market Value of Preferred Stock = Selling Price x No. of Shares = $105 x 9,000 = $945,000

Total Market Value = Market Value of Debt + Market Value of Common Stock + Market Value of Preferred Stock

= $2,600,000 + $3,562,500 + $945,000 = $7,107,500

Weight of Debt(wD) = Market Value of Debt / Total Market Value

= $2,600,000 / $7,107,500 = 36.58%

Weight of Preferred Stock(wP) = Market Value of Preferred Stock / Total Market Value

= $945,000 / $7,107,500 = 13.30%= $3,562,500 / $7,107,500 = 50.12%

Weight of Common Stock(wE) = Market Value of Common Stock / Total Market Value

= $3,562,500 / $7,107,500 = 50.12%

Cost of Debt(kD) = YTM = 7.59%

Cost of Preferred Stock(kP) = Annual Dividend / Current Preferred Share Price

= [$100 x 7%] / $105 = 6.67%

Cost of Common Stock(kE) = Risk-free Rate + [Beta x Market Risk Premium]

= 7% + [1.1 x 9%] = 7% + 9.9% = 16.9%

WACC = [wD x kD x (1 - t)] + [wP x kP] + [wE x kE]

= [0.3658 x 7.59% x (1 - 0.32)] + [0.1330 x 6.67%] + [0.5012 x 16.9%]

= 1.89% + 0.89% + 8.47% = 11.25%