Question

Consider the following information for Evenflow Power Co.

Debt: 4,500 6 percent APR coupon bonds outstanding, $1,000 par value, 21 years to maturity, selling for 105 percent of par; the bonds make semiannual payments.

Common stock: 94,500 shares outstanding, selling for $55 per share; the beta is 1.06. Preferred stock: 15,000 shares of 4.5 percent preferred stock outstanding (note: take this percentage and convert it into decimal format, then multiply times 100 to find the preferred dividend), currently selling for $107 per share.

Market: 7.5 percent market risk premium and 4 percent risk-free rate.

Assume the company's tax rate is 33 percent.

Required: Find the WACC. (Do not round your intermediate calculations.)

Answer 1

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

MV of equity=55*94500

=5197500

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

MV of Bond=1000*4500*1.05

=4725000

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=107*15000

=1605000

MV of firm = MV of Equity + MV of Bond+ MV of Preferred equity

=5197500+4725000+1605000

=11527500

Cost of equity

As per CAPM

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

Cost of equity% = 4 + 1.06 * (7.5)

Cost of equity% = 11.95

Cost of debt

K = Nx2

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

k=1

K =21x2

1050 =∑ [(6*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^21x2

k=1

YTM = 5.5923769489

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

After tax cost of debt = 5.5923769489*(1-0.33)

= 3.746892555763

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 4.5/107*100

=4.21

Weight of equity = MV of Equity/MV of firm

Weight of equity = 5197500/11527500

W(E)=0.4509

Weight of debt = MV of Bond/MV of firm

Weight of debt = 4725000/11527500

W(D)=0.4099

Weight of preferred equity = MV of preferred equity/MV of firm

Weight of preferred equity = 1605000/11527500

W(PE)=0.1392

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

WACC=3.75*0.4099+11.95*0.4509+4.21*0.1392

WACC% = 7.51