Question

FYI: THIS IS A NEW PROBLEM WITH DIFFERENT DATA, PLEASE DO NOT PROVIDE OLD ANSWERS

You are given the following information for Cleen Power Co. Assume the company’s tax rate is 40 percent.

Debt:	8,000 6.9 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 105 percent of par; the bonds make semiannual payments.
Common stock:	410,000 shares outstanding, selling for $59 per share; the beta is 1.15.
Market:	9 percent market risk premium and 4.9 percent risk-free rate.

What is the company's WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

WACC      _____      %

Answer 1

After Tax Cost of Debt

Face Value = $1,000

Coupon Amount = $34.50 [$1,000 x 6.90% x ½]

Bond Price = $1,050 [$1,000 x 105%]

Maturity Years = 40 Years [20 Years x 2]

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

= [$34.50 + {($1,000 – $1,050) / 40 Years)] / [($1,000 + $1050) / 2}]

= [($34.50 - $1.25) / $1,025]

= 0.03225

= 3.225%

Semiannual Yield to Maturity = 3.225%

The Annual Yield to Maturity of the Bond = 6.45% [3.225% x 2]

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

= 6.45% x (1 – 0.40)

= 6.45% x 0.60

= 3.87%

Cost of Equity

Cost of Equity Capital [as per CAPM] = Rf + [Beta x Market Risk Premium]

= 4.90% + [1.15 x 9%]

= 4.90% + 10.35%

= 15.25%

Weight of the Capital Components

Market Value of Debt = $84,00,000 [8,000 x $1,050]

Market Value of Equity = $2,41,90,000 [410,000 x $59]

Total market Value = $3,25,90,000

Weight of Debt = 0.2577 [$84,00,000 / $3,25,90,000]

Weight of Equity = 0.7423 [$2,41,90,000 / $3,25,90,000]

Weighted Average Cost of Capital [WACC]

= [After Tax Cost of Debt x Weight of Debt] + [Cost of equity x Weight of Equity]

= [3.87% x 0.2577] + [15.25% x 0.7423]

= 1.00% + 11.32%

= 12.32%

“Therefore, the Company’s Weighted Average Cost of Capital [WACC] would be 12.32%”