Question

You are given the following information for Lightning Power Co. Assume the company's tax rate is 24 percent.

Debt: 14,000 6.3 percent coupon bonds outstanding, $1,000 par value, 29 years to maturity, selling for 107 percent of par; the bonds make semiannual payments.

Common Stock: 470,000 shares outstanding, selling for $65 per share; beta is 1.16.

Preferred stock: 20,500 shares of 4.1 percent preferred stock outstanding, currently selling for $86 per share. The par value is $100 per share.

Market: 7 percent market risk premium and 5.2 percent risk-free rate.

What is the company's WACC?

Answer 1

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

MV of equity=65*470000

=30550000

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

MV of Bond=1000*14000*1.07

=14980000

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=86*20500

=1763000

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

=30550000+14980000+1763000

=47293000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 30550000/47293000

W(E)=0.646

Weight of debt = MV of Bond/MV of firm

Weight of debt = 14980000/47293000

W(D)=0.3167

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

Weight of preferred equity = 1763000/47293000

W(PE)=0.0373

Cost of equity

As per CAPM

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

Cost of equity% = 5.2 + 1.16 * (7)

Cost of equity% = 13.32

Cost of debt

K = Nx2

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

k=1

K =29x2

1070 =∑ [(6.3*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^29x2

k=1

YTM = 5.7985304185

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

After tax cost of debt = 5.7985304185*(1-0.24)

= 4.40688311806

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 4.1/(86)*100

=4.77

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

WACC=4.41*0.3167+13.32*0.646+4.77*0.0373

WACC =10.18%