Consider the following information for Evenflow Power Co., Debt: 3,500 7 percent

Question

Consider the following information for Evenflow Power Co., Debt: 3,500 7 percent coupon bonds outstanding, $1,000 par value, 19 years to maturity, selling for 105 percent of par; the bonds make semiannual payments. Common stock: 70,000 shares outstanding, selling for $60 per share; the beta is 1.12. Preferred stock: 11,000 shares of 6 percent preferred stock outstanding, currently selling for $107 per share. Market: 7.5 percent market risk premium and 5.5 percent risk-free rate. Assume the company's tax rate is 32 percent. Required: Find the WACC. (Do not round your intermediate calculations.) rev: 09_20_2012 8.88% 9.38% 8.98% 9.83% 9.16%

Explanation / Answer

Answer:-

We will begin by finding the market value of each type of financing. We find:

MVD = 3,500($1,000)(1.05) = $3,675,000

MVE = 70,000($60) = $4,200,000

MVP = 11,000($107) = $1,177,000

And the total market value of the firm is:

V = $3,675,000 + 4,200,000 + 1,177,000 = $9,052,000

Now, we can find the cost of equity using the CAPM. The cost of equity is:

RE = 0.055 + 1.12(0.075) = 0.139 or 13.9%

The cost of debt is the YTM of the bonds, so:

YTM = 3.27% × 2 = 6.54%

And the aftertax cost of debt is:

RD = (1 – 0.32)(0.0654) = 0.044,472 or 4.447%

The cost of preferred stock is:

RP = $6/$107 = 0.05607 or 5.607%

Now we have all of the components to calculate the WACC. The WACC is:

WACC = 0.139(4.20/9.052) + 0.04447(3.675/9.052) + 0.05607(1.177/9.052) =

0.0898205 or 8.98%

Notice that we didn't include the (1 – tC) term in the WACC equation. We used the aftertax cost of debt in the equation, so the term is not needed here.

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