Question

You are given the following information for Huntington Power Co. Assume the company’s tax rate is 40 percent.

Debt:
7,000 6.2 percent coupon bonds outstanding, $1,000 par value, 15 years to maturity, selling for 105 percent of par; the bonds make semiannual payments.
Common stock: 340,000 shares outstanding, selling for $52 per share; the beta is 1.08.
Market: 8 percent market risk premium and 4.2 percent risk-free rate.
What is the company's WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)
WACC %

Answer 1

WACC= 5.76%

Step-by-step explanation:

The weighted average cost of capital (WAAC) is the average cost of all the various sources of long-term finance used by a business weighted according to the proportion which each source of finance bears to the the entire pool of fund.

To calculate the weighted average cost of capital, follow the steps below:

Step 1: Calculate the cost of Debt

The yield to maturity to Maturity can be used to work out the cost of debt using the formula below:

YM =( C + F-P/n) ÷ ( 1/2× (F+P))

C- annual coupon,

F- face value ,

P- current price,

n- number of years to maturity

YM - Yield to maturity

C- 6.2%× 1000 =62 , P- 1.05×1000= 1,050, F- 1000

AYM = 62 + (1000-1050)/15 ÷ 1/2× (1000+1050)

= 58.66 ÷ 1025

Yield to maturity =5.7%

Cost of debt= 5.7%

Step 2: Calculate the cost of Equity

Using the CAPM , the cost of equity can be worked out as follows:

E(r)= Rf +β(Rm-Rf)

E(r) =? , Rf- 4.2%, Rm-8% β- 1.08

E(r) = 4.2% + 1.08×(8-4.2) = 8.3%

Cost of equity= 8.3%

Step 3: Calculate the market value of sources of finance

Market value of equity = 52×340,000= 17,680,000.00

Market value of debt = 7,000×1,000×105 = 735,000,000.00

Step 4: Calculate the WACC

Source cost Market value cost× market value

Equity 8.3% 17,680,000 1,467,440.00

Debt 5.7% 735,000,000 41,895,000.

752,680,000. 43,362,440.

WACC= (43,362,440/ 752,680,000) × 100

= 5.76%

WACC= 5.76%