Question

# Given the following information for Cleen Power Co., find the WACC. Assume the company's tax rate...

Given the following information for Cleen Power Co., find the WACC. Assume the company's tax rate is 35%

Debt: 7,000 6% coupon bonds outstanding, \$1,000 par value, 20 years to maturity, selling for 105% pf par; the bonds make semiannual payments

Common Stock: 180,000 shares outstanding, selling for \$58 per share; the beta is 1.10

Market: 6.5% market risk premium and 4.3% risk-free rate.

Required:

1. Find the market value of each type of financing

Bonds =

Stock =

Total Value of Firm =

2. Use the CAPM to find the cost of equity

CAPM: Rs = Rf + β * (Rm - Rf)

Rf =

β =

Rm - Rf =

Cost of Equity =

3. Calculate the cost of debt (after-tax YTM)

PV

Periods

Payment

FV

YTM =

After tax cost =

4. Calculate the WACC for the company

Debt Weighting

Equity Weighting

WACC =

1)

Market value of bond = 7000 * (1.05 * 1000) = \$7,350,000

Market value of stock = 180,000 * 58 = \$10,440,000

Total value of firm = 7,350,000 + 10,440,000 = \$17,790,000

2)

Risk free = 4.3%

Beta = 1.1

RM - RF = 6.5%

Cost of equity = risk free rate + beta ( market risk premium)

Cost of equity = 0.043 + 1.1 ( 0.065)

Cost of equity = 0.1145 or 11.45%

3)

PV = 1000 * 1.05 = \$1,050

Periods = 20 * 2 = 40

payment = 0.06 * 1000 = 60 / 2 = 30

FV = 1000

YTM using a financial calculator = 5.58%

( keys to use in a financial calculator:2nd I/Y 2, FV 1000, PV -1050, N 40, PMT 30, CPT I/Y

After tax cost = 0.0558 ( 1 - 0.35) = 0.03627 or 3.627%

4)

Debt weighting = 7,350,000 / 17,790,000 = 0.4132

equity weighting = 10,440,000 / 17,790,000 = 0.5868

WACC = 0.4132 * 0.03627 + 0.5868 * 0.1145

WACC = 0.014987 + 0.067189

WACC = 0.08218 or 8.218%

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