Question

You are given the following information for Cleen Power Co. Assume the company’s tax rate is 38 percent. Debt: 9,000 7.6 percent coupon bonds outstanding, $1,000 par value, 30 years to maturity, selling for 105 percent of par; the bonds make semiannual payments. Common stock: 480,000 shares outstanding, selling for $66 per share; the beta is 1.09. Market: 9 percent market risk premium and 5.6 percent risk-free rate. What is the company's WACC?

Answer 1

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

MV of equity=66*480000

=31680000

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

MV of Bond=1000*9000*1.05

=9450000

MV of firm = MV of Equity + MV of Bond

=31680000+9450000

=41130000

Cost of equity

As per CAPM

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

Cost of equity% = 5.6 + 1.09 * (9)

Cost of equity% = 15.41

Cost of debt

K = Nx2

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

k=1

K =30x2

1050 =∑ [(7.6*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^30x2

k=1

YTM = 7.19

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

After tax cost of debt = 7.19*(1-0.38)

= 4.4578

Weight of equity = MV of Equity/MV of firm

Weight of equity = 31680000/41130000

W(E)=0.7702

Weight of debt = MV of Bond/MV of firm

Weight of debt = 9450000/41130000

W(D)=0.2298

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

WACC=4.46*0.2298+15.41*0.7702

WACC% = 12.89