Question

Consider the following information for Evenflow Power Co.,

Debt: 2,500 bonds that each year pay 5 percent of par value as an annual coupon, have a $1,000 par value, and a yield to maturity of 4.74 percent compounded annually. The bonds have 17 years to maturity and currently sell for 103 percent of par (face) value.

Common stock: 52,500 shares outstanding, selling for $61 per share; the beta is 1.08.

Preferred stock: 8,500 preferred shares that pay a dividend of 4.5 percent annually on $100 par value, and currently sell for $106 per share.

Market: 7 percent market risk premium and 4.5 percent risk-free rate.

Assume the company's tax rate is 33 percent. Note: Face value is sometimes used interchangeably with par value. Preferred shares almost always pay a constant dividend, but the dividend is usually quoted as a percent of par value (just like coupons and bonds). So as an example, a 7% preferred dividend on a $100 par value means the annual dividend payment is $7. Required: Find the WACC. (Do not round your intermediate calculations.)

Multiple Choice

A. 7.48%

B. 7.58%

C. 7.98%

D. 8.18%

E. 7.67%

Answer 1

WACC = 7.58%

Step 1 - Calculate Total Capital (Using Market Value in this case as nothing is mentioned) along with the weights

Debt - 2500 bonds x $1030(103% of $1000) = $2575000

Common stock - 52500 shares x $61 = $3202500

Preferred stock - 8500 shares x $106 = $901000

Total Capital = $2575000 + $3202500 + $901000 = $6678500

Weights :-

Debt - $2575000 / $6678500 = 38.56%

Common stock - $3202500 / $6678500 = 47.95%

Preferred stock - $901000 / $6678500 = 13.49%

Step 2 - Calculate cost of individual components of capital :-

Cost of Debt = Yield to maturity(1 - tax rate)

Cost of Debt = 4.74(1 - 0.33)

Cost of Debt = 3.1758%

Cost of Common Stock = risk-free rate + (market risk premium x Beta)

Cost of Common Stock = 4.5 + (7 x 1.08)

Cost of Common Stock = 12.06%

Cost of Preferred stock - Annual Dividend / Current Market price of preferred stock

Cost of Preferred stock - $4.50 / $106

Cost of Preferred stock = 4.245%

Step 3 - Find WACC :-

WACC = (Cost of Debt x Weight of Debt) + (Cost of Common Stock + weight of Common stock) + (Cost of Preferred stock x weight of Preferred stock)

WACC = (3.1758 x 38.56%) x (12.06 x 47.95%) + (4.245 x 13.49%)

WACC = 1.224588 + 5.78277 + 0.572651

WACC = 7.58%