Consider the following information for Evenflow Power Co., Debt: 2,500 6.5 perce

Question

Consider the following information for Evenflow Power Co., Debt: 2,500 6.5 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 104 percent of par; the bonds make semiannual payments. Common stock: 60,000 shares outstanding, selling for $64 per share; the beta is 1.17. Preferred stock: 9,000 shares of 5 percent preferred stock outstanding, currently selling for $107 per share. Market: 7.5 percent market risk premium and 4.5 percent risk-free rate. Assume the company's tax rate is 33 percent.

Required: Find the WACC. (Do not round your intermediate calculations.) rev: 09_20_2012

9.06%

9.34%

8.84%

9.65%

8.94%

Explanation / Answer

We will begin by finding the market value of each type of financing. First we need to find out markeet value of each type of financng , MVd = 2,500($1,000)(1.04) = $2,600,000 MVe = 60,000($64) = $3,840,000 MVp = 9,000($107) = $963,000 And the total market value of the firm is: V =$2,600,000 + $3,840,000 + $963,000 = $7,403,000 Now, we have to find the cost of equity using the CAPM. The cost of equity is: Re= 0.045 + 1.17(0.075) = 0.1328 or 13.28% The cost of debt is: The cost of debt is the YTM of the bonds, so: P0 = $1,040 = $32.5(PVIFAR%,40) + $1,000(PVIFR%,40) R = 3.013% YTM = 4.0465% × 2 = 8.093% And the aftertax cost of debt is: Rd = (1 - 0.33)(0.08093) = 0.05422 or 5.42% The cost of preferred stock is: Rp = $5/$107 = 0.0467or 4.67% Now we have all of the components to calculate the WACC. So the WACC is: WACC = 0.1328(3,840,000/7,403,000) + 0.05422(2,600,000/7,403,000) + 0.0467(963,000/7,403,000) =0.0689 +0.0190+0.0061 =0.0934 or 9.34%

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