Question

You are given the following information for Cleen Power Co. Assume the company’s tax rate is 40 percent.

Debt:	8,000 7.5 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 104 percent of par; the bonds make semiannual payments.
Common stock:	470,000 shares outstanding, selling for $65 per share; the beta is 1.08.
Market:	8 percent market risk premium and 5.5 percent risk-free rate.

What is the company's WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

WACC %

Answer 1

Debt:

Number of Bonds Outstanding = 8000
Current Price = $1040

Market Value of Debt = $1,040 * 8000
Market Value of Debt = $8320000

Face Value of Bond = $1,000
Current Price = $1,040

Annual Coupon Rate = 7.50%
Semi-annual Coupon Rate = 3.75%
Semi-annual Coupon = 3.75% * $1,000
Semi-annual Coupon = $37.50

TIme to Maturity = 25 years or 50 semi-annual period

Let Semi-annual YTM be i%

$1,040 = $37.50 * PVIFA(i%, 50) + $1,000 * PVIF(i%, 50)
i = 3.577%

Semi-annual YTM = 3.577%
Annual YTM = 3.577%*2 = 7.154%

Before-tax Cost of Debt = 7.154%
After-tax Cost of Debt = 7.154% * (1 - 0.40)
After-tax Cost of Debt = 4.2924%

Equity:

Number of Shares Outstanding = 470000
Current Price = $65

Market Value of equity = $65* 470,000
Market Value of Debt = $30550000

Cost of Equity = risk-free rate + beta * market risk premium
Cost of Equity = 0.055 + 1.08 * 0.08
Cost of Equity = 0.1414 = 14.14%

Total Market Value of Firm = Market Value of Debt + Market Value of Equity
Total Market Value of Firm = $8320,000 + $30550000
Total Market Value of Firm = $38870000

Weight of Debt = $8320,000 / $38870,000
Weight of Debt = 0.214

Weight of Equity = $30550,000 / $38870,000
Weight of Equity = 0.786

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Equity * Cost of Equity
WACC = 0.214 * 4.2924% + 0.786 * 14.14%
WACC = 12.03%

So, WACC of Cleen Power Co. is 12.03%