Question

11

You are given the following information for Huntington Power Co. Assume the company’s tax rate is 22 percent.

  

Debt:	31,000 5 percent coupon bonds outstanding, $2,000 par value, 21 years to maturity, selling for 105 percent of par; the bonds make semiannual payments.
Common stock:	475,000 shares outstanding, selling for $77 per share; the beta is 1.11.
Market:	7 percent market risk premium and 4.2 percent risk-free rate.

What is 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.)

Answer 1

Debt:

Number of bonds outstanding = 31,000
Face Value = $2,000
Current Price = 105%*$2,000 = $2,100

Value of Debt = 31,000 * $2,100
Value of Debt = $65,100,000

Annual Coupon Rate = 5%
Semiannual Coupon Rate = 2.50%
Semiannual Coupon = 2.50%*$2,000 = $50

Time to Maturity = 21 years
Semiannual Period to Maturity = 42

Let semiannual YTM be i%

$2,100 = $50 * PVIFA(i%, 42) + $2,000 * PVIF(i%, 42)

Using financial calculator:
N = 42
PV = -2100
PMT = 50
FV = 2000

I = 2.313%

Semiannual YTM = 2.313%
Annual YTM = 2 * 2.313%
Annual YTM = 4.626%

Before-tax Cost of Debt = 4.626%
After-tax Cost of Debt = 4.626% * (1 - 0.22)
After-tax Cost of Debt = 3.608%

Common Stock:

Number of shares outstanding = 475,000
Current Price = $77

Value of Common Stock = 475,000 * $77
Value of Common Stock = $36,575,000

Cost of Common Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Equity = 4.20% + 1.11 * 7.00%
Cost of Common Equity = 11.970%

Value of Firm = Value of Debt + Value of Common Stock
Value of Firm = $65,100,000 + $36,575,000
Value of Firm = $101,675,000

Weight of Debt = $65,100,000 / $101,675,000
Weight of Debt = 0.6403

Weight of Common Stock = $36,575,000 / $101,675,000
Weight of Common Stock = 0.3597

WACC = Weight of Debt*After-tax Cost of Debt + Weight of Common Stock*Cost of Common Stock
WACC = 0.6403 * 3.608% + 0.3597 * 11.970%
WACC = 6.62%