Question

Consider the following information for Watson Power Co.: Debt: Common stock: Preferred stock 5,000 8.5 percent coupon bonds outstanding, $1,000 par value, 21 years to maturity, selling for 104 percent of par; the bonds make semiannual payments. 105,000 shares outstanding, selling for $64 per share; the beta is 1.19. 14,500 shares of 8 percent preferred stock outstanding, currently selling for $106 per share. 9 percent market risk premium andy7.5 percent risk-free rate. Market: Assume the company's tax rate is 34 percent. Find the WACC. Multiple Choice O 12.02% C ) 13.09%

Answer 1

Answer :-

First we find Market value of debt, common stock and preferred stock.

Market value of debt (MV_D​​​​​​)

MV_D = 5000($1,000)(1.04) = $5,200,000

Market value of common stock (MD_E​​​​​​)

MV_E =105,000($64) = $6,720,000

Market value of preferred stock (MD_P​​​​​​)

MD_p = 14,500 (106) = $1,537,000

Total market value of firm =MD_D + MD_E + MD_P

Total market value of firm = $5,200,000 + $6,720,000 + $1,537,000

Total market value of firm = $13,457,000

Cost of equity computed using CAPM :-

Cost of equity = 7.5% +9%(1.19) =18. 21%

Cost of preferred stock = 8%

Cost of debt :-

​​​​YTM ={ c+ (f-p)/n}/(f+p)/2

c = coupon = 1000 × 8.5% =85

f = face value =1000

p = Price =1000 × 104% =1040

n= period = the coupon is paid semiannually n = 21×2 =42

_{​​​​​}YTM ={ 85+(1000-1040)/42}/(1000+1040)/2

YTM = (85 - 0.95)/1020

YTM = 8.24%

After tax Cost of Debt =8.24%(1-0.34)=5.44%

WACC =18.21%(6,720,000/13,457,000) + 8%(1,537,000/13,457,000) +5.44%(5,200,000/13,457,000)

WACC =12.2%