Consider the following information for Evenflow Power Co., Debt: 5,500 8 percent

Question

Consider the following information for Evenflow Power Co.,

Debt: 5,500 8 percent coupon bonds outstanding, $1,000 par value, 18 years to maturity, selling for 104 percent of par; the bonds make semiannual payments.

Common stock: 132,000 shares outstanding, selling for $55 per share; the beta is 1.11. Preferred stock: 19,000 shares of 6.5 percent

preferred stock outstanding, currently selling for $105 per share.

Market: 10 percent market risk premium and 6 percent risk-free rate. Assume the company's tax rate is 32 percent.

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

A. 10.99%

B.12.01%

C.11.49%

D.11.25%

E.11.09%

Explanation / Answer

Kp = Preferred Dividend / Preferred Share Price

= $6.5/$105 = 6.19%

Ke = Rf + beta(Market Risk Premium)

= 6% + 1.11(10%) = 6% + 11.1% = 17.1%

To find the Kd, we need to input the following values into the financial calculator:

This is a semi-annual YTM = 3.79%. So, Annual YTM = 3.79% x 2 = 7.59%

After-Tax Kd = 7.59%(1 - 0.32) = 5.16%

Market Value of Debt = 5,500 x $1,040 = $5,720,000

Market Value of Equity = 132,000 x $55 = $7,260,000

Market Value of preferred stock = 19,000 x $105 = $1,995,000

Total Market Value of the firm = $5,720,000 + $7,260,000 + $1,995,000 = $14,975,000

WACC = (Wd x After-Tax Kd) + (Wp x Kp) + (We x Ke)

= [($5,720,000/$14,975,000) x 5.16%] + [($1,995,000/$14,975,000) x 6.19%] + [($7,260,000/$14,975,000) x 17.1%]

= 1.97% + 0.82% + 8.29% = 11.09%

Hence, Option "E" is correct.

Input 18x2=36 -$1,000x104% = -$1,040 $40 $1,000 TVM N I/Y PV PMT FV Output 3.79%

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