Question

Consider the following information for Evenflow Power Co., Debt: 4,000 5.5 percent coupon bonds outstanding, $1,000 par value, 23 years to maturity, selling for 105 percent of par; the bonds make semiannual payments. Common stock: 96,000 shares outstanding, selling for $58 per share; the beta is 1.15. Preferred stock: 12,000 shares of 4.5 percent preferred stock outstanding, currently selling for $108 per share. Market: 7.5 percent market risk premium and 4.5 percent risk-free rate. Assume the company's tax rate is 32 percent. Required: Find the WACC.

Answer 1

Answer:

Debt:

Number of bonds outstanding = 4,000
Face Value = $1,000
Current Price = 105%*$1,000 = $1,050

Value of Debt = 4,000 * $1,050
Value of Debt = $4,200,000

Annual Coupon Rate = 5.50%
Semiannual Coupon Rate = 2.75%
Semiannual Coupon = 2.75%*$1,000 = $27.50

Time to Maturity = 23 years
Semiannual Period to Maturity = 46

Let semiannual YTM be i%

$1,050 = $27.50 * PVIFA(i%, 46) + $1,000 * PVIF(i%, 46)

Using financial calculator:
N = 46
PV = -1050
PMT = 27.50
FV = 1000

I = 2.56%

Semiannual YTM = 2.56%
Annual YTM = 2 * 2.56%
Annual YTM = 5.12%

Before-tax Cost of Debt = 5.12%
After-tax Cost of Debt = 5.12% * (1 - 0.32)
After-tax Cost of Debt = 3.482%

Preferred Stock:

Number of shares outstanding = 12,000
Current Price = $108
Annual Dividend = 4.50%*$100 = $4.50

Value of Preferred Stock = 12,000 * $105
Value of Preferred Stock = $1,296,000

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $4.50 / $108
Cost of Preferred Stock = 4.167%

Equity:

Number of shares outstanding = 96,000
Current Price = $58

Value of Common Stock = 96,000 * $58
Value of Common Stock = $5,568,000

Cost of Common Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Equity = 4.50% + 1.15 * 7.5%
Cost of Common Equity = 13.125%

Value of Firm = Value of Debt + Value of Preferred Stock + Value of Common Stock
Value of Firm = $4,200,000 + $1,296,000 + $5,568,000
Value of Firm = $11,064,000

Weight of Debt = $4,200,000 / $11,064,000
Weight of Debt = 0.3796

Weight of Preferred Stock = $1,296,000 / $11,064,000
Weight of Preferred Stock = 0.1171

Weight of Common Stock = $5,568,000 / $11,064,000
Weight of Common Stock = 0.5033

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 = (0.3796 * 3.482%) + (0.1171 * 4.167%) + (0.5033 * 13.125%)
WACC = 8.42%