Consider the following information for Evenflow Power Co., Debt: 5,000 6 percent

Question

Consider the following information for Evenflow Power Co.,

Debt: 5,000 6 percent coupon bonds outstanding, $1,000 par value, 23 years to maturity, selling for 103 percent of par; the bonds make semiannual payments.

Common stock: 105,000 shares outstanding, selling for $61 per share; the beta is 1.1.

Preferred stock: 16,000 shares of 5 percent preferred stock outstanding, currently selling for $105 per share.

Market: 7.5 percent market risk premium and 4.5 percent risk-free rate.

Assume the company's tax rate is 34 percent.

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

9.02%

8.65%

8.15%

8.25%

8.35%

Explanation / Answer

Market value of debt = 5,000($1,000)(1.03) = $5,150,000

Market value of Equity = 105,000($61) = $6,405,000

Market value of preferred stock = 16,000($105) = $1,680,000

And the total market value of the firm is:

V = $5,150,000+ 6,405,000+ 1,680,000= $13,235,000

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

RE = 0.05 + 1.1(0.075) = 0.1325 or 13.2%

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

P0 = $1,040 = $42.5(PVIFAR%,40) + $1,000(PVIFR%,40)

R = 3.013%

YTM = 4.0465% × 2 = 8.093%

And the aftertax cost of debt is:

RD = (1 – 0.34)(0.08093) = 0.053414 or 5.3414%

The cost of preferred stock is:

RP = $5/$105 = 0.047619 or 4.76%

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

WACC = rD (1- Tc )*( D / V )+ rE *( E / V )

WACC = 0.1325(6.40/13.235) + 0.053414(5.15/13.235) + 0.047619(1.68/13.235)

WACC = 0.064073 + 0.020784 + 0.006045 = 0.090202 = 9.02%

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.