You are given the following information for Huntington Power Co. Assume the comp

Question

You are given the following information for Huntington Power Co. Assume the company’s tax rate is 40 percent.

7,000 6.2 percent coupon bonds outstanding, $1,000 par value, 15 years to maturity, selling for 105 percent of par; the bonds make semiannual payments.

What is the company's WACC? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16))

You are given the following information for Huntington Power Co. Assume the company’s tax rate is 40 percent.

Explanation / Answer

Answer

find the market value of each type of financing:

       MVD = 7,000($1,000)(1.05) = $7,350,000

       MVE = 340,000($52) = $17,680,000

And the total market value of the firm is:

V = $7,350,000 + 17,680,000 = $25,030,000

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

       RE = .042+ 1.08(.08) = .1284 or 12.84%

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

       YTM = 5.70%

       And the aftertax cost of debt is:

       RD = (1 – .40)(.0570) = .0342 or 3.42%

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

       WACC = .0342(735/2503) + .1284(1768/2503) = . 1007 or 10.07%

       Notice that we didn’t include the (1 – tC) term in the WACC equation. We simply used the aftertax cost of debt in the equation, so the term is not needed here.

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