Question

Consider the following information for Watson Power Co.:

  

Debt:		5,000 7.5 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:		115,000 shares outstanding, selling for $56 per share; the beta is 1.15.
Preferred stock:		17,500 shares of 6.5 percent preferred stock outstanding, currently selling for $107 per share.
Market:		9.5 percent market risk premium and 5.5 percent risk-free rate.

  

Assume the company's tax rate is 32 percent.

     

Find the WACC.

Multiple Choice

• 10.69%

• 10.39%

• 10.49%

• 11.36%

• 10.89%

Answer 1

Coupon = (0.075 * 1000) / 2 = 37.5

Price = 1.05 * 1000 = 1050

Number of periods = 20 * 2 = 40

Yield to maturity = 7.0306%

Keys to use in a financial calculator: 2nd I/Y 2, FV 1000, PV -1050, N 40, PMT 37.5, CPT I/Y

Cost of equity = Risk free rate + beta (market risk premium)

Cost of equity = 5.5% + 1.15 (9.5%)

Cost of equity = 16.425%

Annual preferred dividend = 0.065 * 100 = 6.5

Cost of preferred dividend = (6.5 / 107) * 100

Cost of preferred dividend = 6.0748%

Market value of stock = 115,000 * 56 = 6,440,000

Market value of debt = 5,000 * 1050 = 5,250,000

Market value of preferred stock = 17,500 * 107 = 1,872,500

Total market value = 6,440,000 + 5,250,000 + 1,872,500 = 13,562,500

WACC = Weight of debt*after tax cost of debt + weight of equity*cost of equity + weight of preferred stock*cost of preferred stock

WACC = (5,250,000 / 13,562,500)*0.070306*(1 - 0.32) + (6,440,000 / 13,562,500)*0.16425 + (1,872,500 / 13,562,500)*0.060748

WACC = 0.018506 + 0.07799 + 0.00839

WACC = 0.1049 or 10.49%