Question

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 =

Answer 1

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%