Calculating WACC
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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