You are given the following information for Watson Power Co. Assume the company’
ID: 2793247 • Letter: Y
Question
You are given the following information for Watson Power Co. Assume the company’s tax rate is 40 percent. Debt: 8,000 6.3 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 106 percent of par; the bonds make semiannual payments. Common stock: 350,000 shares outstanding, selling for $53 per share; the beta is 1.09. Preferred stock: 13,000 shares of 3 percent preferred stock outstanding, currently selling for $73 per share. Market: 10 percent market risk premium and 4.3 percent risk-free rate. What is the company's WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) WACC %
Explanation / Answer
Here,
risk free rate =4.3%
market risk premium=10%
beta=1.09
using CAPM
Cost of equity=risk free rate+market risk premium*beta
=4.3+10*1.09=15.2%
for cost of debt we have
par value=1000, time to maturity=20,price=106% of 1000=1060
coupon rate=6.3% coupon payments=63 semiannual coupon payments=63/2=31.5
semi-annual yield to maturity=(((F-P)/2+C)/((F+P)/2))
where F=face value
P=price of bond
C= semi-annual coupon payments
putting value in above equation
semi-annual yield to maturity=((((1000-1060)/2)+31.5)/(1000+1060)/2)
=0.00145~0.145%
yeild to maturity=(1+semi-annual yield to maturity)^2-1
=(1+0.00145)^2-1=0.00291~0.291% after tax cost of debt=cost of debt(1-tax)=0.291%(1-0.4)=0.116%
cost of preference=dividend/market price=30/73=0.41~41%
total capital structure=8000+350000+13000=371000
We=proportion of shares=350000/371000=0.943
Wd=proportion of debt=8000/371000=0.0215
Wp=proportion of preference shares=13000/371000=0.0350
WACC=(We)*cost of equity+(Wd)*after tax cost of debt+Wp*cost of preference=0.943*0.152+0.0215*0.116+0.0350*0.41=0.1601~16.01%
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