Question

You are given the following information for Lightning Power Co. Assume the company’s tax rate is 24 percent. Debt: 19,000 6.8 percent coupon bonds outstanding, $1,000 par value, 24 years to maturity, selling for 111 percent of par; the bonds make semiannual payments. Common stock: 520,000 shares outstanding, selling for $70 per share; beta is 1.21. Preferred stock: 23,000 shares of 4.6 percent preferred stock outstanding, currently selling for $91 per share. The par value is $100 per share. Market: 6 percent market risk premium and 5.5 percent risk-free rate. What is the company's WACC?

Answer 1

Company's WACC is 9.6%

Step-by-step explanation:

WACC is the average cost of capital of the firm based on the weightage of the debt and weightage of the equity multiplied to their respective costs.

Formula for WACC

Weighted Average Cost of Capital = (Cost of Equity x Weightage of equity) + (Cost of preferred Stock x Weightage of preferred Stock ) + (Cost of Debt (1 -t) x Weightage of Debt)

Market Values

Equity = 520,000 x $70 = $36,400,000

Preferred = 23,000 x $91 = $2,093,000

Debt = $1,110 x 19,000 = $21,090,000

Total Value = $36,400,000 + $2,093,000 + $21,090,000 = $59,583,000

Cost of Equity :

We can calculate cost of equity using CAPM

Capital asset pricing model measure the expected return on an asset or investment. it is used to make decision for addition of specific investment in a well diversified portfolio.

Formula for CAPM

Cost of Equity = Risk free rate + beta ( market return - risk free rate )

Cost of Equity = Rf + β ( Rm - Rf )

Cost of Equity = 5.5% + 1.21 ( 6% )

Cost of Equity = 12.76%

Cost of Preferred stock = 4.6%

We need to calculate the yield to maturity

Yield to maturity = [ C + ( F - P ) / n ] / [ (F + P ) / 2 ]

Placing value in the formula

Yield to maturity = [ 34 + ( $1,000 - $1,110 ) / 48 ] / [ ( $1,000 + $1,110 ) / 2 ]

Yield to maturity = 3% semiannually = 6% annually

Placing values in the formula

Weighted Average Cost of Capital = (12.76% x $36,400,000 / $59,583,000 ) + ( 4.6% x $2,093,000 / $59,583,000 ) + (6% (1 - 0.24 ) x $21,090,000 / $59,583,000 )

Weighted Average Cost of Capital = 7.80% + 0.16% + 1.61% = 9.57%