Question

You are given the following information for Huntington Power Co. Assume the company’s tax rate is 25 percent.

  

Debt:	26,000 5.4 percent coupon bonds outstanding, $2,000 par value, 25 years to maturity, selling for 105 percent of par; the bonds make semiannual payments.
Common stock:	450,000 shares outstanding, selling for $72 per share; the beta is 1.06.
Market:	8 percent market risk premium and 3.7 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

MV of equity=Price of equity*number of shares outstanding

MV of equity=72*450000

=32400000

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=2000*26000*1.05

=54600000

MV of firm = MV of Equity + MV of Bond

=32400000+54600000

=87000000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 32400000/87000000

W(E)=0.3724

Weight of debt = MV of Bond/MV of firm

Weight of debt = 54600000/87000000

W(D)=0.6276

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 3.7 + 1.06 * (8)

Cost of equity% = 12.18

Cost of debt

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =25x2

2100 =∑ [(5.4*2000/200)/(1 + YTM/200)^k]     +   2000/(1 + YTM/200)^25x2

k=1

YTM = 5.0458039328

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 5.0458039328*(1-0.25)

= 3.7843529496

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=3.78*0.6276+12.18*0.3724

WACC =6.91%