Question

Given the following information for Framingham Power Co., find the WACC. Assume the company’s tax rate is 35 percent. Debt: $10,000,000 6 percent coupon bonds outstanding, 25 years to maturity, selling for 92 percent of par; the bonds make annual payments. Common Stock: 200,000 shares outstanding, selling for $49 per share; the beta is 1.4. Market: 8 percent market risk premium and 4 percent risk-free rate.

WACC=

Answer 1

Face value = $10,000,000

Coupon = 0.06 * 10,000,000 = 600,000

Price = 0.92 * 10,000,000 = 9,200,000

Yield to maturity = 6.666%

Keys to use in a financial calculator: FV 10,000,000, PV -9,200,000, PMT 600,000, N 25, CPT I/Y

Market value of common stock = 200,000 * 49 = 9,800,000

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

Cost of equity = 4% + 1.4 (8%)

Cost of equity = 15.2%

Total market value of capital structure = 9,200,000 + 9,800,000 = 19,000,000

WACC = Weight of debt*after tax cost of debt + weight of equity*cost of equity

WACC = (9,200,000/19,000,000)*0.0666*(1 - 0.35) + (9,800,000/19,000,000)*0.152

WACC = 0.020961 + 0.0784

WACC = 0.0994 or 9.94%