Consider the following information for Evenflow Power Co. 5,000 6 percent coupon

Question

Consider the following information for Evenflow Power Co. 5,000 6 percent coupon bonds outstanding, $1,000 par value, 17 years to maturity, selling for 103 percent of par; the bonds make semiannual payments. 110,000 shares outstanding, selling for $60 per share; the beta is 1.2. 17,000 shares of 5.5 percent preferred stock outstanding, currently selling for $105 per share. 7 percent market risk premium and 5 percent risk-free rate. Debt: Common stock Preferred stock Market: Assume the company's tax rate is 34 percent Required: Find the WACC. (Do not round your intermediate calculations.) ? 8.56% o 9.06% o 9.4% ? 8.66% o 876%

Explanation / Answer

WACC 8.66%

Working:

Step-1:Calculation of weight of each component a. Component Quantity Market price per unit Total Debt         5,000 $         1,030 $       51,50,000 Common Stock 1,10,000 $ 60 $       66,00,000 Preferred stock      17,000 $ 105 $       17,85,000 Total $    1,35,35,000 b. Weight of: Debt $ 51,50,000 / $    1,35,35,000 =           0.38 Common Stock $ 66,00,000 / $    1,35,35,000 =           0.49 Preferred stock $ 17,85,000 / $    1,35,35,000 =           0.13           1.00 Step-2:Calculation of cost of each component a. Before tax cost of debt = (Average income/Average Investment)*2 = (30+(1000-1030)/34)/((1000+1030)/2)*2 = 5.74% Par Value $         1,000 Coupon Interest $         1,000 x 3% = $          30 Semi annual period 34 Current Price $         1,030 b. After tax cost of debt = 5.74% x (1-0.34) = 3.79% c. Cost of equity = Risk free + Beta *risk premium = 5% + 1.2*7% = 13.4% d. Cost of preferred stock = Preferred dividend/Current Price = $         5.5 / 105 = 5.24% Working: Preferred dividend = $        100 x 5.50% = $         5.5 Step-3:Calculation of WACC Component Cost Weight Weighted Cost Debt 3.79%                0.38 1.441% Common Stock 13.4%                0.49 6.534% Preferred stock 5.24%                0.13 0.691% WACC 8.666%

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