Question

Information on Lightning Power Co., is shown below. Assume the company’s tax rate is 22 percent.

Debt:	18,200 6.1 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 107.8 percent of par; the bonds make semiannual payments.
Common stock:	620,000 shares outstanding, selling for $85.25 per share; beta is 1.15.
Preferred stock:	28,500 shares of 4.25 percent preferred stock outstanding, currently selling for $92.70 per share. The par value is $100.
Market:	6.8 percent market risk premium and 3.4 percent risk-free rate.

What is the company's cost of each form of financing? -cost equity % -aftertax cost of debt % -cost of preferred stock % Calculate the companys WACC %

Answer 1

Debt:

Number of bonds outstanding = 18,200
Face Value = $1,000

Current Price = 107.80% * $1,000
Current Price = $1,078

Market Value of Debt = 18,200 * $1,078
Market Value of Debt = $19,619,600

Annual Coupon Rate = 6.10%
Semiannual Coupon Rate = 3.05%
Semiannual Coupon = 3.05% * $1,000
Semiannual Coupon = $30.50

Time to Maturity = 25 years
Semiannual Period to Maturity = 50

Let Semiannual YTM be i%

$1,078 = $30.50 * PVIFA(i%, 50) + $1,000 * PVIF(i%, 50)

Using financial calculator:
N = 50
PV = -1078
PMT = 30.50
FV = 1000

I = 2.760%

Semiannual YTM = 2.76%
Annual YTM = 2 * 2.76%
Annual YTM = 5.52%

Before-tax Cost of Debt = 5.52%
After-tax Cost of Debt = 5.52% * (1 - 0.22)
After-tax Cost of Debt = 4.306%

Preferred Stock:

Number of shares outstanding = 28,500
Current Price = $92.70

Annual Dividend = 4.25% * $100
Annual Dividend = $4.25

Market Value of Preferred Stock = 28,500 * $92.70
Market Value of Preferred Stock = $2,641,950

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $4.25 / $92.70
Cost of Preferred Stock = 4.585%

Common Stock:

Number of shares outstanding = 620,000
Current Price = $85.25

Market Value of Common Stock = 620,000 * $85.25
Market Value of Common Stock = $52,855,000

Cost of Common Stock = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Stock = 3.40% + 1.15 * 6.80%
Cost of Common Stock = 11.220%

Market Value of Firm = Market Value of Debt + Market Value of Preferred Stock + Market Value of Common Stock
Market Value of Firm = $19,619,600 + $2,641,950 + $52,855,000
Market Value of Firm = $75,116,550

Weight of Debt = $19,619,600 / $75,116,550
Weight of Debt = 0.2612

Weight of Preferred Stock = $2,641,950 / $75,116,550
Weight of Preferred Stock = 0.0352

Weight of Common Stock = $52,855,000 / $75,116,550
Weight of Common Stock = 0.7036

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Preferred Stock * Cost of Preferred Stock + Weight of Common Stock * Cost of Common Stock
WACC = 0.2612 * 4.306% + 0.0352 * 4.585% + 0.7036 * 11.220%
WACC = 9.18%