Question

Consider the following information for Evenflow Power Co.,

  

Debt:		3,000 7 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 103 percent of par; the bonds make semiannual payments.
Common stock:		72,000 shares outstanding, selling for $59 per share; the beta is 1.14.
Preferred stock:		10,000 shares of 5.5 percent preferred stock outstanding, currently selling for $105 per share.
Market:		8 percent market risk premium and 4.5 percent risk-free rate.

  

Assume the company's tax rate is 33 percent.

  

Required:

  

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

Answer 1

Weighted average cost of Capital (WACC)=(weight of debt*after tax cost of debt)+(weight of common stock*cost of common stock)+ (weight of preferred stock*cost of preferred stock)

Before tax cost of debt needs to be found using RATE function in EXCEL

=RATE(nper,pmt,pv,fv,type)

Please remember the bond payments are semi-annual

nper=2*maturity time=2*20=40

pmt=semi-annual coupon payment=(coupon rate*face value)/2=(7%*1000)/2=35

pv=present bond price=103%*1000=1030

fv=1000

=RATE(40,35,-1030,1000,0)

RATE=semi-annual yield=3.36%

Annual yield=before tax cost of debt=2*3.36%=6.72%

After tax cost of debt=before tax cost of debt*(1-tax rate)=6.72%*(1-33%)=4.51%

Cost of common stock=risk free rate+(Beta*market risk premium)=4.5%+(1.14*8%)=13.62%

Cost of preferred stock=5.5%

Market value of the debt=Number of bonds*price of the bond=3000*1030=$3,090,000

Market value of common stock=Outstanding shares*share price=72,000*$59=$4,248,000

Market value of preferred stock=Outstanding shares*share price=10,000*105=$1,050,000

Total value=$3,090,000+$4,248,000+$$1,050,000=$8,388,000

Weight of debt=Market value of debt/Total Value=$3,090,000/$8,388,000=36.84%

Weight of Common stock=Market value of common stock/Total Value=$4,248,000/$8,388,000=50.64%

Weight of Preferred stock=Market value of preferred stock/Total value= $1,050,000 /$8,388,000=12.52%

WACC=(36.84%*4.51%)+(50.64%*13.62%)+(12.52%*5.5%)=9.25%