Final answer:
The company's Weighted Average Cost of Capital (WACC) is 10.44%. To calculate WACC, we need to determine the cost of each type of capital and the proportion of each source in the company's capital structure.
Step-by-step explanation:
The company's Weighted Average Cost of Capital (WACC) is the average rate of return required by the company's investors. To calculate WACC, we need to determine the cost of each type of capital and the proportion of each source in the company's capital structure.
Debt: 5,000 6.5 percent coupon bonds outstanding, $1,000 par value, 17 years to maturity, selling for 102 percent of par; the bonds make semiannual payments.
The cost of debt can be calculated using the formula:
Cost of debt = (Coupon rate x Par value) / Bond price
So, for EvenFlow Power Co:
Cost of debt = (6.5% x $1,000) / $1,020 = 6.37%
Common stock: 105,000 shares outstanding, selling for $59 per share; the beta is 1.17.
To calculate the cost of equity, we can use the Capital Asset Pricing Model (CAPM) which is:
Cost of equity = Risk-free rate + Beta x Market risk premium
Using the given information:
Cost of equity = 5% + 1.17 x 8.5% = 14.995%
Preferred stock: 18,000 shares of 6 percent preferred stock outstanding, currently selling for $105 per share.
The cost of preferred stock can be calculated using the formula:
Cost of preferred stock = Preferred stock dividend / Preferred stock price
So, for EvenFlow Power Co:
Cost of preferred stock = (6% x $105) / $105 = 6%
We have the following information:
Total debt = $5,000 x $1,000 = $5,000,000
Total equity = 105,000 x $59 = $6,195,000
Total preferred stock = 18,000 x $105 = $1,890,000
Total capital = Total debt + Total equity + Total preferred stock = $5,000,000 + $6,195,000 + $1,890,000 = $13,085,000
The weight of each source can be calculated as:
Weight of debt = Total debt / Total capital = $5,000,000 / $13,085,000
Weight of equity = Total equity / Total capital = $6,195,000 / $13,085,000
Weight of preferred stock = Total preferred stock / Total capital = $1,890,000 / $13,085,000
WACC = Cost of debt x Weight of debt + Cost of equity x Weight of equity + Cost of preferred stock x Weight of preferred stock
Substituting the values:
WACC = 6.37% x ($5,000,000 / $13,085,000) + 14.995% x ($6,195,000 / $13,085,000) + 6% x ($1,890,000 / $13,085,000)
WACC = 2.44% + 7.14% + 0.86% = 10.44%