Question

You are given the following information for Huntington Power Co. Assume the company’s tax rate is 22 percent.

  

Debt:	23,000 5.1 percent coupon bonds outstanding, $2,000 par value, 22 years to maturity, selling for 108 percent of par; the bonds make semiannual payments.
Common stock:	435,000 shares outstanding, selling for $69 per share; the beta is .94.
Market:	8 percent market risk premium and 3.4 percent risk-free rate.

Answer 1

Price = 1.08 * 2000 = 2,160

Coupon = (0.051 * 2,000) / 2 = 51

Number of periods = 22 * 2 = 44

yield to maturity = 4.5222%

Keys to use in a financial calculator: 2nd I/Y 2, FV 2000, PV -2160, PMT 51, N 44, CPT I/Y

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

Cost of equity = 0.034 + 0.94 (0.08)

Cost of equity = 0.1092 or 10.92%

Total market value of bond = 2,160 * 23,000 = 49,680,000

Total market value of equity = 435,000 * 69 = 30,015,000

Total market value = 49,680,000 + 30,015,000 = 79,695,000

WACC = (49,680,000 / 79,695,000)*0.045222*(1 - 0.22) + (30,015,000 / 79,695,000)*0.1092

WACC = 0.02199 + 0.04113

WACC = 0.0631 or 6.31%