Question

Given the following information for Janicek Power Co., find the WACC. Assume the company's tax rate is 35 percent.

Debt: 6,000 9 percent coupon bonds outstanding. $1,000 par value, 10 years to maturity, selling for 104 percent of par, the bonds make semiannual payments.

Preferred stock: 8,000 shares of 4.75 percent (dividends) preferred stock outstanding, currently selling for $60 per share.

Common stock: 90,000 shares outstanding, selling for $75 per share with a beta of 1.20

Market: 6 percent market risk premium and 5 percent T-bill rate.

Answer 1

WACC = (weight of debt * cost of debt) + (weight of preferred stock * cost of preferred stock) + (weight of equity * cost of equity)

market value of debt = 6,000 * $1,000 * (104 / 100) = $6,240,000

market value of preferred stock = 8000 * $60 = $480,000

market value of equity = 90,000 * $75 = $6,750,000

total market value = $13,470,000

weight of debt = $6,240,000 / $13,470,000 = 0.463

weight of preferred stock = $480,000 / $13,470,000 = 0.036

weight of equity = $6,750,000 / $13,470,000 = 0.501

cost of debt = YTM of bond * (1 - tax rate)

YTM is calculated using RATE function in Excel with these inputs :

nper = 10*2 (10 years to maturity with 2 semiannual coupon payments each year)

pmt = 1000 * 9% /2 (semiannual coupon payment = face value * annual coupon rate / 2)

pv = -1000 * 104 / 100 (current bond price = face value * 104 / 100)

fv = 1000 (face value of the bond receivable on maturity)

the RATE is calculated to be 4.20%. This is the semiannual YTM. To calculate the annual YTM, we multiply by 2. Annual YTM is 8.40%

cost of debt = 8.40% * (1 - 35%) ==> 5.46%

cost of preferred stock = dividend / current price = 4.75 / 60 = 7.92%

cost of equity = risk free rate + (beta * market risk premium)

cost of equity = 5% + (1.20 * 6%) ==> 12.20%

WACC = (0.463 * 5.46%) + (0.036 * 7.92%) + (0.501 * 12.20%) ==> 8.93%