Consider the following information for Evenflow Power Co., Debt: 5,500 8.5 perce

Question

Consider the following information for Evenflow Power Co.,

Debt:

5,500 8.5 percent coupon bonds outstanding,
$1,000 par value, 21 years to maturity,
selling for 105 percent of par;
the bonds make semiannual payments.

Common stock:

132,000 shares outstanding,
selling for $56 per share;
the beta is 1.15.

Preferred stock:

18,500 shares of 7.5 percent preferred stock outstanding,
currently selling for $106 per share.

Market:

9 percent market risk premium and 7 percent risk-free rate.

Assume the company's tax rate is 31 percent.

Required:

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

Note: Preferred share annual dividends are quoted as a percent of par, 7% in this problem. Par for preferred stock is almost always either $25 or $100. The text (as in this problem) always uses a $100 par unless noted otherwise.

a. 12.45%

b. 11.5%

c. 11.4%

d. 11.9%

e. 11.72%

Consider the following information for Evenflow Power Co.,

Explanation / Answer

Capital Structure of the company:

Total Capital = (5,500 bonds x $1,000) + (132,000 Shares x $56) + (18,500 Shares x $100) = $14,742,000

Weight of debt = (5,500 bonds x $1,000) / $14,742,000 = 0.373084
Weight of equity = (132,000 Shares x $56) / $14,742,000 = 0.501425
Weight of preferred stock = (18,500 Shares x $100) / $14,742,000 = 0.125492

Cost of Debt: It is the after tax YTM of the bond.

Bond Value = C/2 {[1-(1+(YTM/2))-2t/(YTM/2)] + [F / (1+ (YTM/2))2t]

B0 = $1050
C = $1,000 x 8.5% = $85
F = $1,000
YTM = the yield to maturity on the bond
t = 21

$1050 = $85/2 {[1-(1+(YTM/2))-42/(YTM/2)] + [$1,000 / (1+ (YTM/2))42]
YTM = 8%

After-tax YTM = 8% x (1-0.31) = 5.52%

Cost of Equity: It is the required rate of return on the stock as per CAPM.

Cost of Preferred Stock = 7.5%

WACC = (0.373084 x 0.0552) + (0.501425 x 0.1780) + (0.125492 x 0.075) = 0.119 or 11.9%

So, the option d is correct.

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