Question

Given the following information for Watson Power Co., find the WACC. Assume the company’s tax rate is 21 percent.

Debt: 50,000 bonds with a 4.8 percent coupon outstanding, $1,000 par value, 15 years to maturity, selling for 105 percent of par; the bonds make semiannual payments.

Common stock: 975,000 shares outstanding, selling for $42 per share; the beta is 1.11.

Preferred 85,000 shares of 3.8 percent preferred stock outstanding, currently stock: selling for $60 per share.

Assume par value is $105. Market: 7 percent market risk premium and 2.5 percent risk-free rate.

Answer 1

 

Calculation of WACC

a)After tax cost of debt(Kd)

Cost of Debt=[Annual coupon+(Face Value-Purchase Price)/years to maturity]/(Face Value+Purchase Price)/2

=[$48+($1000-$1050)/15]/($1000+$1050)/2

=0.0436 or 4.36%

After tax cost of debt=Cost of debt(1-tax rate)

=4.36%(1-0.21)

=3.44%

b)Cost of common stock(Ke)

Ke=Risk free rate+Beta*Market risk premium

=2.5%+1.11*7%

=10.27%

c)Cost of preferred stock(Kp)

Kp=[Annual dividend/Share Price]*100

=[(3.8%*$105)/$60]*100

=6.65%

d)Weight of each source of capital

Total market value of Capital=Market value of debt+Market value of common stock+Market value of preferred stock

=50,000*$1050+975,000*$42+85,000*60

=$52,500,000+$40,950,000+$5100,000

=$98550,000

Weight of debt(Wd)=Market value of debt/Total market value of Capital

=$52,500,000/$98550,000=0.53

Weight of Common stock(We)=$40,950,000/$98550,000=0.42

Weight of Preferred stock(Wp)=$5100,000/$98550,000=0.05

WACC=Ke*We+Kp*Wp+Kd*Wd

=10.27%*0.42+6.65%*0.05+4.36%*0.53

=6.9567% or 6.96%