Question

Consider the following information for Evenflow Power Co.,

  

Debt:		2,500 5.5 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 104 percent of par; the bonds make semiannual payments.
Common stock:		50,000 shares outstanding, selling for $63 per share; the beta is 1.12.
Preferred stock:		9,000 shares of 4.5 percent preferred stock outstanding, currently selling for $105 per share.
Market:		7 percent market risk premium and 4 percent risk-free rate.

  

Assume the company's tax rate is 31 percent.

  

Required:

  

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

• 8.19%

• 7.68%

• 7.46%

• 7.96%

• 7.56%

Answer 1

Coupon = (0.055 * 1000) / 2 = 27.5

Number of periods = 20 * 2 = 40

Price = 1.04 * 1000 = 1040

Yield to maturity = 5.1766%

Keys to use in a financial calculator: 2nd I/Y 2, FV 1000, PV -1040, N 40, PMT 27.5, CPT I/Y

Assuming face value of preferred stock is $100

Preferred dividend = 0.045 * 100 = 4.5

Cost of preferred dividend = (Dividend / price) * 100

Cost of preferred dividend = (4.5 / 105) * 100

Cost of preferred dividend = 4.2857%

Cost of equity = Risk free rate +beta (market risk premium)

Cost of equity = 4% + 1.12 (7%)

Cost of equity = 11.84%

Market value of debt = 2,500 * 1040 = 2,600,000

Market value of preferred stock = 9,000 * 105 = 945,000

Market value of common stock = 50,000 * 63 = 3,150,000

Total market value = 2,600,000 + 945,000 + 3,150,000 = 6,695,000

WACC = Weights * costs

WACC = (2,600,000 / 6,695,000)*0.051766*(1 - 0.31) + (945,000 / 6,695,000)*0.042857 + (3,150,000 / 6,695,000)*0.1184

WACC = 0.013871 + 0.006049 + 0.055707

WACC = 0.0756 or 7.56%