You are given the following information for Watson Power Co. Assume the company’
ID: 2745105 • Letter: Y
Question
You are given the following information for Watson Power Co. Assume the company’s tax rate is 35 percent. Debt: 9,000 coupon bonds outstanding, yielding 6.46 percent and paying a 7 percent coupon, $1,000 par value, 20 years to maturity, selling for 106 percent of par; the bonds make semiannual payments. Common stock: 420,000 shares outstanding, selling for $60 per share; the beta is 1.03. Preferred stock: 20,000 shares of 4 percent preferred stock outstanding, currently selling for $80 per share. Market: 9 percent market risk premium and 5 percent risk-free rate. What is the company's WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Explanation / Answer
WACC = (WE x KE) + (WD x KDafter tax) + (WP x KP)
Market Value of Debt = 9,000 * 1,000 * 106%
Market Value of Debt = $9,540,000
Market value of Common Stock = 420,000 * $60
Market value of Common Stock = $25,200,000
Market Value of Preferred Stock = 20,000 * $80
Market Value of Preferred Stock = $1,600,000
Total market value of firm = Market value of debt +Market value of common stock + Market value ofpreferred stock
Total market value of firm = 9,540,000 + 25,200,000 + 1,600,000
Total market value of firm = $36,340,000
Weight of Debt = 9,540,000/36,340,000
Weight of Debt (WD)= 0.2625
Weight of Common Stock = 25,200,000/36,340,000
Weight of Common Stock (WE) = 0.693
Weight of Preferred Stock = 1,600,000/36,340,000
Weight of Preferred Stock (WP) = 0.044
Before-Tax Cost of Debt = 6.46%
After-Tax Cost of Debt = 6.46%*(1-0.35)
Cost of Debt (KD) = 4.20%
Cost of Preferred Stock = Annual dividend / Current market price
Cost of Preferred Stock = 4/80
Cost of Preferred Stock (KP) = 5%
Cost of Equity = Risk free rate + (Beta x Market Risk Premium)
Cost of Equity = 0.05 + 1.03*0.09
Cost of Equity (KE) = 0.1427 or 14.27%
WACC = (WE x KE) + (WP x KP) + (WD x KDafter tax)
WACC = 0.1427 * 0.693 + 0.05 * 0.044 + 0.042 * 0.2625
WACC = 0.1121
WACC = 11.21%
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