Question

In: Finance

Information on Gerken Power Co., is shown below. Assume the company’s tax rate is 38 percent....

Information on Gerken Power Co., is shown below. Assume the company’s tax rate is 38 percent.

Debt:

8,800 8.1 percent coupon bonds outstanding, $1,000 par value, 22 years to maturity, selling for 103.5 percent of par; the bonds make semiannual payments.

Common stock: 213,000 shares outstanding, selling for $83.30 per share; beta is 1.18.
Preferred stock:

12,300 shares of 5.9 percent preferred stock outstanding, currently selling for $97.70 per share.

Market: 7.15 percent market risk premium and 4.95 percent risk-free rate.


Required:
Calculate the company's WACC. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Solutions

Expert Solution

MV of equity=Price of equity*number of shares outstanding
MV of equity=83.3*213000
=17742900
MV of Bond=Par value*bonds outstanding*%age of par
MV of Bond=1000*8800*1.035
=9108000
MV of Preferred equity=Price*number of shares outstanding
MV of Preferred equity=97.7*12300
=1201710
MV of firm = MV of Equity + MV of Bond+ MV of Preferred equity
=17742900+9108000+1201710
=28052610
Cost of equity
As per CAPM
Cost of equity = risk-free rate + beta * (Market risk premium)
Cost of equity% = 4.95 + 1.18 * (7.15)
Cost of equity% = 13.39
Cost of debt
                  K = Nx2
Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2
                   k=1
                  K =22x2
1035 =∑ [(8.1*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^22x2
                   k=1
YTM = 7.7656442479
After tax cost of debt = cost of debt*(1-tax rate)
After tax cost of debt = 7.7656442479*(1-0.38)
= 4.814699433698
cost of preferred equity
cost of preferred equity = Preferred dividend/price*100
cost of preferred equity = 5.9/97.7*100
=6.04
Weight of equity = MV of Equity/MV of firm
Weight of equity = 17742900/28052610
W(E)=0.6325
Weight of debt = MV of Bond/MV of firm
Weight of debt = 9108000/28052610
W(D)=0.3247
Weight of preferred equity = MV of preferred equity/MV of firm
Weight of preferred equity = 1201710/28052610
W(PE)=0.0428
WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)
WACC=4.81*0.3247+13.39*0.6325+6.04*0.0428
WACC% = 10.29

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