Consider the following information for Evenflow Power Co., Debt: 3,000 8.5 perce

Question

Consider the following information for Evenflow Power Co.,

Debt: 3,000 8.5 percent coupon bonds outstanding, $1,000 par value, 22 years to maturity, selling for 104 percent of par; the bonds make semiannual payments and have a YTM of 8.11%.

Common stock: 72,000 shares outstanding, selling for $65 per share; the beta is 1.15.

Preferred stock: 9,500 shares of preferred stock outstanding that pay an annual dividend of 7.5 percent of par, selling for $106 per share.

Market: 10 percent market risk premium and 7 percent risk-free rate. Assume the company's tax rate is 34 percent.

Find the WACC.

HINT: Use the Security Market Line to get the cost of the common equity. Use the perpetuity equation to get the cost of preferred equity, and keep in mind that par value of preferred stock is $100 (this is used to get the dividend). Don't forget to adjust the cost of debt for taxes (and don't bother to convert the YTM into an EAR, but leave it as an APR). You will also need to calculate the market value of all three types of securities to get the capital structure weights. Now you are ready to get the WACC.

-12.54%

-12.94%

-13.51%

-12.71%

-12.44%

Explanation / Answer

cost of equity = 7% + 10*1.15 = 18.5%

cost of preffered stock = 7.5/106 = 7.08%

after tax cost of debt = 8.11% * (1-0.34) = 5.3526%

market value of equity = 72000 * 65 = 4680000

market value of debt = 3000 * 1040 = 3120000

market value of preferred stock = 9500 * 106 = 1007000

total value = 8807000

wacc = (4680000/8807000) * 18.5% + (3120000/8807000) * 5.3526% + (1007000/8807000) * 7.08%

= 12.54%

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