Question

Consider the following information for Evenflow Power Co.,

  

Debt:		5,000 7.5 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 104 percent of par; the bonds make semiannual payments.
Common stock:		125,000 shares outstanding, selling for $56 per share; the beta is 1.12.
Preferred stock:		16,500 shares of 6.5 percent preferred stock outstanding, currently selling for $106 per share.
Market:		8.5 percent market risk premium and 6 percent risk-free rate.

  

Assume the company's tax rate is 34 percent.

  

Required:

  

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

11.21%

10.46%

10.71%

10.21%

10.31%

Answer 1

Answer is 10.31%

Debt:

Number of bonds outstanding = 5,000
Face Value = $1,000
Current Price = 104%*$1,000 = $1,040

Value of Debt = 5,000 * $1,040
Value of Debt = $5,200,000

Annual Coupon Rate = 7.5%
Semiannual Coupon Rate = 3.75%
Semiannual Coupon = 3.75%*$1,000 = $37.50

Time to Maturity = 20 years
Semiannual Period to Maturity = 40

Let semiannual YTM be i%

$1,040 = $37.50 * PVIFA(i%, 40) + $1,000 * PVIF(i%, 40)

Using financial calculator:
N = 40
PV = -1040
PMT = 37.5
FV = 1000

I = 3.56%

Semiannual YTM = 3.56%
Annual YTM = 2 * 3.56%
Annual YTM = 7.12%

Before-tax Cost of Debt = 7.12%
After-tax Cost of Debt = 7.12% * (1 - 0.34)
After-tax Cost of Debt = 4.70%

Preferred Stock:

Number of shares outstanding = 16,500
Current Price = $106
Annual Dividend = 6.50%*$100 = $6.50

Value of Preferred Stock = 16,500 * $106
Value of Preferred Stock = $1,749,000

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $6.50 / $106
Cost of Preferred Stock = 6.132%

Equity:

Number of shares outstanding = 125,000
Current Price = $56

Value of Common Stock = 125,000 * $56
Value of Common Stock = $7,000,000

Cost of Common Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Equity = 6% + 1.12 * 8.5%
Cost of Common Equity = 15.52%

Value of Firm = Value of Debt + Value of Preferred Stock + Value of Common Stock
Value of Firm = $5,200,000 + $1,749,000 + $7,000,000
Value of Firm = $13,949,000

Weight of Debt = $5,200,000/$13,949,000
Weight of Debt = 0.3728

Weight of Preferred Stock = $1,749,000/$13,949,000
Weight of Preferred Stock = 0.1254

Weight of Common Stock = $7,000,000/$13,949,000
Weight of Common Stock = 0.5018

WACC = Weight of Debt*After-tax Cost of Debt + Weight of Preferred Stock*Cost of Preferred Stock + Weight of Common Stock*Cost of Common Stock
WACC = 0.3728*4.70% + 0.1254*6.132% + 0.5018*15.52%
WACC = 10.31%