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14. Finding the WACC Given the following information for Lightning Power Co., find the WACC. Assume the company’s tax rate is 21 percent. Debt: 16,000 6.2 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 108 percent of par; the bonds make semiannual payments. Common stock: 535,000 shares outstanding, selling for $81 per share; beta is 1.20. Preferred stock: 20,000 shares of 4.2 percent preferred stock outstanding, currently selling for $92 per share. The par value is $100. Market: 7 percent market risk premium and 3.1 percent riskfree rate.

Answer 1

Debt:

Number of bonds outstanding = 16,000
Face Value = $1,000
Current Price = 108%*$1,000 = $1,080

Value of Debt = 16,000 * $1,080
Value of Debt = $17,280,000

Annual Coupon Rate = 6.2%
Semiannual Coupon Rate = 3.1%
Semiannual Coupon = 3.1%*$1,000 = $31

Time to Maturity = 25 years
Semiannual Period to Maturity = 50

Let semiannual YTM be i%

$1,080 = $31 * PVIFA(i%, 50) + $1,000 * PVIF(i%, 50)

Using financial calculator:
N = 50
PV = -1080
PMT = 31
FV = 1000

I = 2.80%

Semiannual YTM = 2.80%
Annual YTM = 2 * 2.80%
Annual YTM = 5.6%

Before-tax Cost of Debt = 5.6%
After-tax Cost of Debt = 5.6% * (1 - 0.21)
After-tax Cost of Debt = 4.42%

Preferred Stock:

Number of shares outstanding = 20,000
Current Price = $92
Annual Dividend = 4.20%*$100 = $4.20

Value of Preferred Stock = 20,000 * $92
Value of Preferred Stock = $1,840,000

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $4.20 / $92
Cost of Preferred Stock = 4.57%

Equity:

Number of shares outstanding = 535,000
Current Price = $81

Value of Common Stock = 535,000 * $81
Value of Common Stock = $43,335,000

Cost of Common Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Equity = 3.1% + 1.20 * 7%
Cost of Common Equity = 11.5%

Value of Firm = Value of Debt + Value of Preferred Stock + Value of Common Stock
Value of Firm = $17,280,000 + $1,840,000 + $43,335,000
Value of Firm = $62,455,000

Weight of Debt = $17,280,000/$62,455,000
Weight of Debt = 0.2767

Weight of Preferred Stock = $1,840,000/$62,455,000
Weight of Preferred Stock = 0.0295

Weight of Common Stock = $43,335,000/$62,455,000
Weight of Common Stock = 0.6939

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 = 0.2767*4.42% + 0.0295*4.57% + 0.6939*11.5%
WACC = 9.34%