You are given the following information for Watson Power Co. Assume the company’s tax rate is 30 percent.

You are given the following information for Watson Power Co. Assume the company’s tax rate is 30 percent.

Debt:	9,000 6.4 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 107 percent of par; the bonds make semiannual payments.
Common stock:	360,000 shares outstanding, selling for $54 per share; the beta is 1.10.
Preferred stock:	14,000 shares of 4 percent preferred stock outstanding, currently selling for $74 per share.
Market:	11 percent market risk premium and 4.4 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:

We will begin by finding the market value of each type of financing. We find:

MVD = 9,000($1,000)(1.07) = $9,630,000

MVE = 360,000($54) = $19,440,000

MVP = 14,000($74) = $1,036,000

And the total market value of the firm is:

V = $9,630,000 + 19,440,000 + 1,036,000

V = $30,106,000

Now, we can find the cost of equity using the CAPM. The cost of equity is:

RE = .044 + 1.10(.11)

RE = .1650, or 16.50%

The cost of debt is the YTM of the bonds, so:

P0 = $1,070 = $32.00(PVIFAR%,40) + $1,000(PVIFR%,40)

R = 2.902%

YTM = 2.902% × 2 = 5.80%

And the aftertax cost of debt is:

RD = (1 – .30)(.0580)

RD = .0406, or 4.06%

The cost of preferred stock is:

RP = $4 / $74

RP = .0541, or 5.41%

Now we have all of the components to calculate the WACC. The WACC is:

WACC = .0406(9.630 / 30.106) + .1650(19.440 / 30.106) + .0541(1.036 / 30.106)

WACC = .1214, or 12.14%

Notice that we didn’t include the (1 – TC) term in the WACC equation. We used the aftertax cost of debt in the equation, so the term is not needed here.