Consider the following information for Evenflow Power Co., Debt: 2,000 7.5 perce

Question

Consider the following information for Evenflow Power Co.,

Debt:      
2,000 7.5 percent coupon bonds outstanding, $1,000 par value, 21 years to maturity, selling for 103 percent of par; the bonds make semiannual payments and have a YTM of 7.22%.  

Common stock:      
46,000 shares outstanding, selling for $58 per share; the beta is 1.17.  

Preferred stock:      
6,500 shares of preferred stock outstanding, paying 6.5 percent on $100 of par, and currently selling for $104 per share.  

Market:      
8.5 percent market risk premium and 5.5 percent risk-free rate.  

Assume the company's tax rate is 33 percent.

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

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. Don't forget to adjust the cost of debt for taxes (and don't 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

Possible Choices:
10.25%
11.16%
10.65%
10.15%
10.37%

Please post an explaination, if possible. THANK YOU!

Explanation / Answer

Answer:-

Cost of Debt (Kd)

Coupon rate = 7.5% semi-annuallly

= 7.5 / 2 = 3.75%

Years = 21 years semi-annually

= 21 * 2 = 42 semi-annually

Selling Price = 1000 * 103%

= 1030

Kd = 3% + [(1177.8025 - 1030) / (1177.8025 - 949.56)] * (4 -3)

= 3 + [147.8025 / 228.2425] * 1

= 3.648% semi-annually

= 3.648 * 2

= 7.296%

Kd (after tax) = 7.296 * (1 - 33%)

= 4.888%

Cost of Equity (Ke)

Risk free return (Rf)= 5.5%

Market risk premium (Rm - Rf) = 8.5%

Beta = 1.17

Ke = Rf + Beta * (Rm - Rf)

= 5.5 + 1.17 * 8.5

= 15.445%

Cost of Preference Stock (Kp)

Kp = 100 * 6.5% / 104

= 6.5 / 104

= 6.25%

Calculate WACC

WACC = 10.25%

Particulars Market Value Ratio Debt =(2000 * 1000 * 103%) = 2060000 =(2060000 / 5404000) = .38 Equity =(46000 * 58) = 2668000 =(2668000 / 5404000) = .49 Preference Stock =(6500 * 104) = 676000 =(676000 / 5404000) = ..13 TOTAL 5404000 1

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