Question

Consider the following information for Watson Power Co.:

Debt: 5,500 6.5 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 103 percent of par; the bonds make semiannual payments.

Common stock: 126,500 shares outstanding, selling for $55 per share; the beta is 1.08.

Preferred stock: 17,000 shares of 5.5 percent preferred stock outstanding, currently selling for $104 per share.

Market: 8.5 percent market risk premium and 5 percent risk-free rate.

Assume the company's tax rate is 32 percent.

Find the WACC.

Multiple Choice:

A) 9.96%

B) 9.28%

C) 9.07%

D) 9.17%

E) 9.57%

Answer 1

Calculating Cost of Debt,

Using TVM Calculation,

I = [FV = 1000, PV = 1030, T = 40, PMT = 32.50]

I = 6.24%

EAR = (1 + 0.0624/2)² - 1 = 6.34%

Market Value of Debt = 5,500*1,030 = $5,665,000

Calculating Cost of Equity,

Using CAPM Model,

Cost of Equity = 0.05 + 1.08(0.085)

Cost of Equity = 14.18%

Market Value of Equity = 126,500*55 = $6,957,500

Calculating Cost of Preferred Stock,

Cost of Preferred Stock = 5.5/104

Cost of Preferred Stock = 5.29%

Amount of Preferred Stock = 17,000*104 = $1,768,000

Weight of Debt = 5,665,000/(5,665,000 + 6,957,500 + 1,768,000)

Weight of Debt = 5,665,000/14,390,500 = 0.3937

Weight of Equity = 6,957,500/14,390,500 = 0.4835

Weight of Preferred Stock = 0.1228

WACC = (0.3937)(1 - 0.32)(0.0634) + 0.4835(0.1418) + 0.1228(0.0529)

WACC = 9.17%