You are given the following information for Lightning Power Co Assume the compan

Question

You are given the following information for Lightning Power Co Assume the company's tax rate is 35 percent Debt: 6,000 6.7 percent coupon bonds outstanding. $1,000 par value. 25 years to maturity, selling for 103 percent of par; the bonds make semiannual payments Common stock: 390,000 shares outstanding, selling for $57 per share; the beta is 1.13 Preferred stock: 17,000 shares of 4 percent preferred stock outstanding, currently selling for $77 per share Market 6 percent market risk premium and 4.70 percent risk-free rate What is the company's WACC? (Do not round intermediate calculations and round your final answer to 2 decimal places, (e.g., 32.16))

Explanation / Answer

Before going towards solution let's understand the concept of WACC first.

WACC stands for Weighted Average Cost of Capital. It is basically the weighted average cost of each Interest bearing security in Capital Structure. Where, weight is market value of each security.

Kd stands for cost of debt- it is post tax cost of debt

Kp stands for cost of preference shares. It is already post tax distribution so no tax adjustment required.

Ke stands for cost of equity. It is calculated using slope of Security Market Line that is

Rf+(Rm-Rf)*beta. Here Rf is Risk free return, Rm-Rf is Market risk premium and beta is sensitivity of your stock with fluctuations in market. It is basically unsystematic risk.

Wacc formula- ((Kd(1-t)*D)+(Ke*E)+(Kp*P))/D+E+P.

Now let's come to problem.

Kd=(6.7*0.65)= 4.355

Kp=4% ( given)

ke= Rf+(Rm-Rf)*beta.= 4.70+(6)*1.13=11.48Rf+(Rm-Rf)*beta.

WACC= (4.355%*1030*6000)+(4%*77*17000)+(11.48%*57*390000)/(1030*6000)+(77*17000)+(57*390000)= 9.66%

Hope this will help you out.

All the best.

George

Mail- caparthverma@gmail.com

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