You are given the following information for Watson Power Co. Assume the company\

Question

You are given the following information for Watson Power Co. Assume the company's tax rate is 35 percent. 6.000 6.7 percent coupon Pones outstanding. $1.000 par value. 25 years to maturity, selling for 103 percent of par; the Ponds make semiannual payments. 390.000 shares outstanding, selling for $57 per share; the beta is 1.13. 17,000 shares of 4 percent preferred stock outstanding, currently selling for $77 per share. 6 percent market risk premium and 4.7 percent risk-free rate. What is the company's WACC? (Do not round informed ate calculations Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Explanation / Answer

Answer: Calculation of the Company's WACC:

Formula used for calculation of WACC (Weighted Average Cost of Capital) is:

KWACC = (WE x KE) + (WD x KDafter tax) + (WP x KP)

In which:

KWACC = Weighted average cost of capital

WE = Market value weight of Common Stock

KE = Cost of Equity (Common stock)

WD = Market value weight of Debt

KDafter tax = After-tax cost of debt

WP = Market value weight of Preferred Stock

KP = Cost of Preferred Stock

Market value of debt = 6000 x ($1,000 x 103%) = 6000 x $1,030 = $6180000

Market value of common stock = 390,000 x $57 = $22,230,000

Market value of preferred stock = 17,000 x $77 = $1,309,000

Total market value of firm = Market value of debt +Market value of common stock + Market value of preferred stock = $6180000 + $22,230,000 + $ 1,309,000= $29719000

Before tax Cost of Debt (KD before tax) = ($33.5 x A.P.V.F50 R%) + ($1,000 / (1 + R%)50)

Using interpolation (or trial rate method), R = 3.228%

Annual after before tax cost of debt = 3.228% x 2 = 6.456%

After tax cost of debt (KDafter tax) = 6.456% x (1 – 0.35)

= 6.456% x 0.65

= 4.1964%

Using CAPM, Cost of Equity (KE) = Risk free rate + (Beta x Market Risk Premium)

= 4.7% + (1.13 x 6%) = 11.48%

Cost of Preferred Stock (KP) = Annual dividend / Current market price

=$4/$77=5.2%

Capital structure Market value Weight Cost of capital WACC Equity $22,230,000 0.748006 11.48% 8.587 Debt $6,180,000 0.207948 4.20% 0.873 Preferrence stock $1,309,000 0.044046 5.20% 0.229 Total $29,719,000 1 9.689

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