Question

In: Accounting

You are given the following information for Watson Power Co. Assume the company’s tax rate is...

You are given the following information for Watson Power Co. Assume the company’s tax rate is 25 percent. Debt: 15,000 6.4 percent coupon bonds outstanding, $1,000 par value, 28 years to maturity, selling for 106 percent of par; the bonds make semiannual payments. Common stock: 480,000 shares outstanding, selling for $66 per share; the beta is 1.17. Preferred stock: 21,000 shares of 4.2 percent preferred stock outstanding, currently selling for $87 per share. The par value is $100 per share. Market: 5 percent market risk premium and 5.3 percent risk-free rate. What is the company's WACC?

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Expert Solution

Market Value of each capital Structure

Debt = $1,59,00,000 [15,000 x $1,060]

Preferred Stock = $18,27,000 [21,000 x $87]

Equity = $316,80,000 [480,000x $66]

Total Market Value = $4,94,07,000

Cost of Debt

Cost of Debt = Yield to Maturity (YTM)

Yield to Maturity [YTM] = Coupon Amount + [(Face Value – Bond Price) / Maturity Years] / [(Face Value + Bond Price)/2]

= [{$32.00 + [($1,000 – 1,060) / 56 Years)}] / [($1,000 + 1,060) / 2]

= 2.98%

Semiannual YTM = 2.98%

Annual YTM = 5.96% [2.98% x 2]

After Tax Cost of Debt = Bond’s YTM x [ 1 – Tax Rate]

= 5.96% x (1 – 0.25)

= 4.47%

Cost of Preferred Stock

Cost of Preferred Stock = [Preferred Dividend / Selling Price] x 100

= [$4.20 / 87.00] x 100

= 4.83%

Cost of Equity

Cost of Equity = Rf + [B x Risk Premium]

= 5.30% + [1.17 x 5%]

= 11.15%

Weighted Average Cost of Capital (WACC)

Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of Preferred stock x Weight of preferred stock] + [Cost of equity x Weight of Equity]

= [4.47% x (159,00,000 / 494,07,000)] + [4.83% x (18,27,000 / 494,07,000)] + [11.15% x (316,80,000 / 494,07,000)]

= 1.44% + 0.18% + 7.15%

= 8.77%

“Hence, The Weighted Average Cost of Capital (WACC) = 8.77%”


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