Consider the following information for Evenflow Power Co., Debt: 3,500 6 percent

Question

Consider the following information for Evenflow Power Co., Debt: 3,500 6 percent coupon bonds outstanding, $1,000 par value, 19 years to maturity, selling for 104 percent of par; the bonds make semiannual payments. Common stock: 70,000 shares outstanding, selling for $56 per share; the beta is 1.18. Preferred stock: 10,500 shares of 5 percent preferred stock outstanding, currently selling for $107 per share. Market: 7.5 percent market risk premium and 5 percent risk-free rate. Assume the company's tax rate is 35 percent.

Required: Find the WACC.

8.4%

8.8%

8.54%

8.3%

9.23%

Explanation / Answer

Market value of equity = price* number of shares = 70000*56= 3.92m

Market value of prefered equity =  price* number of shares = 10500*107= 1.1235m

Market value of debt = number of bonds*par value* price in terms of par = 3500*1000*1.04 = 3.64m

Market value of firm = Market value of equity+Market value of prefered equity+Market value of debt

= 8.6835m

Weight of equity = Market value of equity/ Market value of firm = 3.92/8.6835 = 0.4514

Weight of Preferred equity = Market value of preferred equity/ Market value of firm = 1.1235/8.6835 = 0.1293

Weight of debt = Market value of debt/ Market value of firm = 3.64/8.6835 = 0.4191

b.

Cost of equity = risk-free rate + beta * (market risk premium) = 5+1.18*7.5 = 13.85%

Cost of preferred equity = payment on prefered stock/current price = 5*100/107 = 4.67%

Cost of debt =

                    K =Nx2          
BOND PRICE= [(Semi-annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^(Nx2)
                   k=1

                    K= 19x2           
1040             = [(6*1000/(100*2))/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^19x2
                   k=1

cost of debt(YTM) =5.6%

WACC = cost of debt*(1-tax rate)*weight of debt+

cost of equity*weight of equity+

cost of preferred equity*weight of preferred equity

=5.6*(1-0.35)*0.4191+4.67*0.1293+13.85*0.4514

=8.38%

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