You are given the following information for Watson Power Co. Assume the company’
ID: 2765225 • Letter: Y
Question
You are given the following information for Watson Power Co. Assume the company’s tax rate is 30 percent. Debt: 6,000 7.9 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 108 percent of par; the bonds make semiannual payments. Common stock: 510,000 shares outstanding, selling for $69 per share; the beta is 1.12. Preferred stock: 29,000 shares of 4 percent preferred stock outstanding, currently selling for $89 per share. Market: 10 percent market risk premium and 5.9 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 %Explanation / Answer
Solution:
Cost of Debt after tax = [Interest (1 –Tax Rate) + (Redemption Value – Net Proceeds) / life] / (Redemption Value + Net Proceeds)/2
= [$79 (1 – 0.30) + ($1,000 - $1,080)/25] / ($1,000 + $1,080)/2
= ($55.3 - $3.2) / $1,040
= 0.050096 or 5%
Cost of Equity (using CAPM Model) = Risk Free Return + Beta x Market Risk Premium
= 5.9% + 1.12 x 10%
= 17.10%
Cost of Preferred Stock = Preferred Dividend / Current Market Price x 100 = ($100 x 4%) / $89 x 100
= $4 / $89 x 100 = 0.04494 or 4.50%
Assumed Par Value of Preferred Stock = $100
WACC at Market Value Weight
Capital Structure
Value
Weight
(Individual Value of Capital / Total Capital)
Cost of Capital (%)
WACC
Debt (6,000 x $1080)
$6,480,000
0.15
5.00
0.73
Common Stock (510,000 x $69)
$35,190,000
0.80
17.10
13.60
Preferred Stock (29,000 x $89)
$2,581,000
0.06
4.50
0.26
Total
$44,251,000
14.59
WACC = 14.59%
Capital Structure
Value
Weight
(Individual Value of Capital / Total Capital)
Cost of Capital (%)
WACC
Debt (6,000 x $1080)
$6,480,000
0.15
5.00
0.73
Common Stock (510,000 x $69)
$35,190,000
0.80
17.10
13.60
Preferred Stock (29,000 x $89)
$2,581,000
0.06
4.50
0.26
Total
$44,251,000
14.59
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