Question

Consider the following information for Evenflow Power Co.,

  

Debt:		4,500 8 percent coupon bonds outstanding, $1,000 par value, 22 years to maturity, selling for 103 percent of par; the bonds make semiannual payments.
Common stock:		94,500 shares outstanding, selling for $58 per share; the beta is 1.11.
Preferred stock:		16,000 shares of 6.5 percent preferred stock outstanding, currently selling for $104 per share.
Market:		8.5 percent market risk premium and 6 percent risk-free rate.

  

Assume the company's tax rate is 35 percent.

  

Required:

  

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

Answer 1

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

MV of equity=58*94500

=5481000

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

MV of Bond=1000*4500*1.03

=4635000

MV of firm = MV of Equity + MV of Bond

=5481000+4635000

=10116000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 5481000/10116000

W(E)=0.5418

Weight of debt = MV of Bond/MV of firm

Weight of debt = 4635000/10116000

W(D)=0.4582

Cost of equity

As per CAPM

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

Cost of equity% = 6 + 1.11 * (8.5)

Cost of equity% = 15.44

Cost of debt

K = Nx2

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

k=1

K =22x2

1030 =∑ [(8*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^22x2

k=1

YTM = 7.7145795184

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

After tax cost of debt = 7.7145795184*(1-0.35)

= 5.01447668696

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

WACC=5.01*0.4582+15.44*0.5418

WACC =10.66%