Question

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

Debt: 5,000 7.2 percent coupon bonds outstanding, $1,000 par value, 30 years to maturity, selling for 108 percent of par; the bonds make semiannual payments.
Common stock: 440,000 shares outstanding, selling for $62 per share; the beta is 1.05.
Preferred stock: 22,000 shares of 3 percent preferred stock outstanding, currently selling for $82 per share.
Market: 11 percent market risk premium and 5.2 percent risk-free rate.
What is the company's WACC?

Answer 1

14.06%

Step-by-step explanation:

The computation of the company WACC is shown below:

Particulars After tax Market value Weights WACC

(cost % × weights)

Common stock 16.75% $27,280,000 0.79 13.25%

(440,000 shares × $62)

Preferred stock 3.66% $1,804,000 0.05 0.19%

(22,000 shares × $82)

Debt 3.95% $5,400,000 0.16 0.62%

(5,000 shares × $1,000 × 108%)

Total $34,484,000 1

WACC 14.06%

Working note

Cost of common equity is

= Risk free rate of return + Beta × market risk premium

= 5.2% + 1.05 × 11%

= 5.2% + 11.55%

= 16.75%

Cost of preferred stock is

= Annual dividend ÷ Market price per share

= 0.03 ÷ $82

= 3.65%

And, the cost of debt is calculated by using the RATE formula i.e

= RATE(NPER,PMT,-PV,FV)

= RATE(30 × 2, $1,000 × 7.2% ÷ 2, -$1,080, $1,000)

After calculated this, the rate of interest should be multiplied by 2 and then applied the tax rate of (1 - 0.40)

So, the rate is 3.95%