Question

. You are given the following information for Watson Power Co. Assume the company’s tax rate is 40 percent. Debt: 8,000 6.2 percent coupon bonds outstanding, $1,000 par value, 10 years to maturity, selling for 110 percent of par; the bonds make semiannual payments. Common stock: 300,000 shares outstanding, selling for $50 per share; the beta is 1.08. Preferred stock: 12,000 shares of 7 percent preferred stock outstanding, currently selling for $70 per share. Market: 8 percent market risk premium and 4.2 percent risk-free rate. What is the company's WACC? Please do this step by step. Thank you!

Answer 1

MV of equity=Price of equity*number of shares outstanding

MV of equity=50*300000

=15000000

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=1000*8000*1.1

=8800000

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=70*12000

=840000

MV of firm = MV of Equity + MV of Bond+ MV of Preferred equity

=15000000+8800000+840000

=24640000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 15000000/24640000

W(E)=0.6088

Weight of debt = MV of Bond/MV of firm

Weight of debt = 8800000/24640000

W(D)=0.3571

Weight of preferred equity = MV of preferred equity/MV of firm

Weight of preferred equity = 840000/24640000

W(PE)=0.0341

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 4.2 + 1.08 * (8)

Cost of equity% = 12.84

Cost of debt

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =10x2

1100 =∑ [(6.2*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^10x2

k=1

YTM = 4.9217916231

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

After tax cost of debt = 4.9217916231*(1-0.4)

= 2.95307497386

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 7/(70)*100

=10

WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=2.95*0.3571+12.84*0.6088+10*0.0341

WACC =9.21%