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.)

8.65%

8.15%

9.02%

8.35%

8.25%

Explanation / Answer

Cost of debt will be after-tax YTM of the bond.

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

B0 = $1,030    (103% x $1,000)
C = $1,000 x 6% = $60
F = $1,000
YTM = the yield to maturity on the bond
t = 23

$1,030 = $60/2 {[1-(1+(YTM/2))-46/(YTM/2)] + [$1,000 / (1+ (YTM/2))46]
YTM = 5.76%

After-tax YTM = 5.76% x (1-tax) = 5.76% x 0.66 = 3.80%

Cost of Equity will the expected return as per CAPM:

Cost of Preferred Stock = 5%

Total Capital = Total Debt + Total Equity + Total Preferred Stock
                       = (5,000 x $1,000) + (105,000 x $61) + (16,000 x $105) = $13,085,000

Weight of debt = (5,000 x $1,000)/$13,085,000 = 0.382117
Weight of equity = (105,000 x $61)/$13,085,000 = 0.489492
Weight of preferred Stock = (16,000 x $105)/$13,085,000 = 0.128391

WACC = (0.382117 x 3.8%) + (0.489492 x 12.75%) + (0.128391 x 5%) = 8.35%

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