Question

You are given the following information for Huntington Power Co. Assume the company’s tax rate is 25 percent. Debt: 22,000 5 percent coupon bonds outstanding, $2,000 par value, 25 years to maturity, selling for 107 percent of par; the bonds make semiannual payments. Common stock: 430,000 shares outstanding, selling for $68 per share; the beta is .93. Market: 7 percent market risk premium and 3.3 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

Debt:

Number of bonds outstanding = 22,000
Face Value = $2,000

Current Price = 107% * $2,000
Current Price = $2,140

Market Value of Debt = 22,000 * $2,140
Market Value of Debt = $47,080,000

Annual Coupon Rate = 5.00%
Semiannual Coupon Rate = 5.00%
Semiannual Coupon = 2.50% * $2,000
Semiannual Coupon = $50

Time to Maturity = 25 years
Semiannual Period to Maturity = 50

Let Semiannual YTM be i%

$2,140 = $50 * PVIFA(i%, 50) + $2,000 * PVIF(i%, 50)

Using financial calculator:
N = 50
PV = -2140
PMT = 50
FV = 2000

I = 2.265%

Semiannual YTM = 2.265%
Annual YTM = 2 * 2.265%
Annual YTM = 4.53%

Before-tax Cost of Debt = 4.53%
After-tax Cost of Debt = 4.53% * (1 - 0.25)
After-tax Cost of Debt = 3.3975%

Common Stock:

Number of shares outstanding = 430,000
Current Price = $68

Market Value of Common Stock = 430,000 * $68
Market Value of Common Stock = $29,240,000

Cost of Common Stock = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Stock = 3.30% + 0.93 * 7.00%
Cost of Common Stock = 9.81%

Market Value of Firm = Market Value of Debt + Market Value of Common Stock
Market Value of Firm = $47,080,000 + $29,240,000
Market Value of Firm = $76,320,000

Weight of Debt = $47,080,000 / $76,320,000
Weight of Debt = 0.6169

Weight of Common Stock = $29,240,000 / $76,320,000
Weight of Common Stock = 0.3831

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Common Stock * Cost of Common Stock
WACC = 0.6169 * 3.3975% + 0.3831 * 9.81%
WACC = 5.85%