Question

You are given the following information for Huntington Power Co. Assume the company’s tax rate is 23 percent.

Debt: 24,000 5.2 percent coupon bonds outstanding, $2,000 par value, 23 years to maturity, selling for 107 percent of par; the bonds make semiannual payments.

Common stock: 440,000 shares outstanding, selling for $70 per share; the beta is .95.

Market: 6 percent market risk premium and 3.5 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=70*440000

=30800000

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

MV of Bond=2000*24000*1.07

=51360000

MV of firm = MV of Equity + MV of Bond

=30800000+51360000

=82160000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 30800000/82160000

W(E)=0.3749

Weight of debt = MV of Bond/MV of firm

Weight of debt = 51360000/82160000

W(D)=0.6251

Cost of equity

As per CAPM

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

Cost of equity% = 3.5 + 0.95 * (6)

Cost of equity% = 9.2

Cost of debt

K = Nx2

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

k=1

K =23x2

2140 =∑ [(5.2*2000/200)/(1 + YTM/200)^k]     +   2000/(1 + YTM/200)^23x2

k=1

YTM = 4.6988909729

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

After tax cost of debt = 4.6988909729*(1-0.23)

= 3.618146049133

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

WACC=3.62*0.6251+9.2*0.3749

WACC =5.71%