Question

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

You are given the following information for Lightning Power Co. Assume the company’s tax rate is 23 percent. Debt: 13,000 6.2 percent coupon bonds outstanding, $1,000 par value, 28 years to maturity, selling for 108 percent of par; the bonds make semiannual payments. Common stock: 460,000 shares outstanding, selling for $64 per share; beta is 1.13. Preferred stock: 20,000 shares of 4 percent preferred stock outstanding, currently selling for $85 per share. The par value is $100 per share. Market: 6 percent market risk premium and 5.1 percent risk-free rate. What is the company's WACC?

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Answer #1
MV of equity=Price of equity*number of shares outstanding
MV of equity=64*460000
=29440000
MV of Bond=Par value*bonds outstanding*%age of par
MV of Bond=1000*13000*1.08
=14040000
MV of Preferred equity=Price*number of shares outstanding
MV of Preferred equity=85*20000
=1700000
MV of firm = MV of Equity + MV of Bond+ MV of Preferred equity
=29440000+14040000+1700000
=45180000
Weight of equity = MV of Equity/MV of firm
Weight of equity = 29440000/45180000
W(E)=0.6516
Weight of debt = MV of Bond/MV of firm
Weight of debt = 14040000/45180000
W(D)=0.3108
Weight of preferred equity = MV of preferred equity/MV of firm
Weight of preferred equity = 1700000/45180000
W(PE)=0.0376
Cost of equity
As per CAPM
Cost of equity = risk-free rate + beta * (Market risk premium)
Cost of equity% = 5.1 + 1.13 * (6)
Cost of equity% = 11.88
Cost of debt
                  K = Nx2
Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2
                   k=1
                  K =28x2
1080 =∑ [(6.2*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^28x2
                   k=1
YTM = 5.6290145584
After tax cost of debt = cost of debt*(1-tax rate)
After tax cost of debt = 5.6290145584*(1-0.23)
= 4.334341209968
cost of preferred equity
cost of preferred equity = Preferred dividend/price*100
cost of preferred equity = 4/(85)*100
=4.71
WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)
WACC=4.33*0.3108+11.88*0.6516+4.71*0.0376
WACC =9.26%
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