help plz You are given the following information for Lightning Power Co. Assume

ID: 2654259 • Letter: H

Question

help plz

You are given the following information for Lightning Power Co. Assume the company?s tax rate is 38 percent. Debt: 7,000 6.8 percent coupon bonds outstanding, $1000 par value, 30 years to maturity, selling for 104 percent of par; the bonds make semiannual payments. Common stock: 400,000 shares outstanding, selling for $58 per share; the beta is 1.14. Preferred stock: 18,000 shares of 5 percent preferred stock outstanding, currently selling for $78 per share. Market: 7 percent market risk premium and 4.80 percent risk-free rate. What is the company?s WACC?

Explanation / Answer

(‘1) Calculation of cost of debt- Cost of debt is nothing but yield to maturity of bond

Yield to maturity is nothing but the rate of return at which all future cash flows will become equal to current market price.

Current Market Price = PV of Coupon payments + PV of FV of bond

1040= 34 [ 1- (1+0.5 YTM)-2 x 30 / 0.5 YTM] + 1000 / ( 1+0.5 YTM )2 x30

YTM = 6.5 %

So cost of debt Rd = 6.5 %

(‘2) Cost of Preferred stock

Rps = Dps / Price

Rps = 5/78 = 6.41 %

(3) Cost of Common Stock

Rs = Risk Free rate + Beta x Market Risk Premium

Rs = 4.80 + 1.14 x 7

Rs = 12.78 %

(‘4) Calculation of Weights of Sources

Particular

Number

Market Price ($)

Market Value (4)

Weight (%)

Cost

WACC

Debt

7,000

1040

7,280,000

22.83

4.03 %

0.920

Common Stock

400,000

23,200,000

72.77

12.78 %

9.299

Preferred Stock

18,000

1,404,000

4.40

6.41 %

0.282

31,884,000

10.50

WACC = 10.50 %

WACC= Wd x Rd x ( 1- Tax rate) + Wps x Rps + WCE x Rs

Post Tax Debt cost will be considered in WACC

Post Tax cost of debt= Cost x ( 1- Tax Rate )

Post Tax Cost = 6.5 x ( 1-0.38) = 4.03 %