Consider the following information for Evenflow Power Co., Debt: 3,500 8.5 perce
ID: 2796413 • Letter: C
Question
Consider the following information for Evenflow Power Co.,
Debt: 3,500 8.5 percent coupon bonds outstanding, $1,000 par value, 23 years to maturity, selling for 102 percent of par; the bonds make semiannual payments.
Common stock: 80,500 shares outstanding, selling for $62 per share; the beta is 1.08.
Preferred stock: 10,500 shares of 8 percent preferred stock outstanding, currently selling for $104 per share. Market: 9 percent market risk premium and 8 percent risk-free rate.
Assume the company's tax rate is 34 percent.
Required: Find the WACC. (Do not round your intermediate calculations.)
12.15% 11.96% 13.1% 12.46% 12.06%
Explanation / Answer
Value of debt = 3500 * 1020 = 3570000
Value of equity = 80500 * 62 = 4991000
Value of preferred stock = 10500*104 = 1092000
Total = 3570000 + 4991000 + 1092000 = 9653000
Cost of debt:
Input the following values in financial calculator:
PV = 1020
PMT = 0.085*1000/2 = 42.5
N = 23*2 = 46
FV = 1000
I/Y = ?
CPT I/Y-> = 0.0830 = 8.30%
Cost of debt = 8.30%
Cost of equity:
According to CAPM,
Cost of equity = risk free rate + beta*market risk premium
cost of equity = 8% + 1.08*9% = 17.72%
cost of preferred stock:
Cost of preferred stock = dividend/price = 8/104 = 7.770%
WACC = rD (1- Tc )*( D / V )+ rE *( E / V )
Where...
rD = The required return of the firm's Debt financing
(1-Tc) = The Tax adjustment for interest expense
(D/V) = (Debt/Total Value)
rE= the firm's cost of equity
(E/V) = (Equity/Total Value)
WACC = 3570000/9653000*0.0830*(1-0.34) + 4991000/9653000*0.1772 + 1092000/9653000*0.0770 = 0.12060 = 12.06%
Option E.
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