Information on Janicek Power Co., is shown below. Assume the company’s tax rate
ID: 2461812 • Letter: I
Question
Information on Janicek Power Co., is shown below. Assume the company’s tax rate is 34 percent.
Debt: 10,100 8.7 percent coupon bonds outstanding, $1,000 par value, 24 years to maturity, selling for 96.0 percent of par; the bonds make semiannual payments.
Common stock: 226,000 shares outstanding, selling for $84.6 per share; beta is 1.31.
Preferred stock: 13,600 shares of 5.80 percent preferred stock outstanding, currently selling for $96.4 per share.
Market: 7.05 percent market risk premium and 4.85 percent risk-free rate.
Calculate the WACC
Explanation / Answer
Calculation of yield to maturity for bond.
Market price = $1000 x 96% = $960
Let YTM = R
$960 = interest x PVIFA ( R, 48) + $1000 x PVIF (R, 48)
$960 = $43.5 x PVIFA ( R, 48) + $1000 x PVIF (R, 48)
when R = 10%,
$43.5 x PVIFA ( R, 48) + $1000 x PVIF (R, 48) = $43.5 x 9.897 + $1000 x 0.01 = $441
When R = 3%
$43.5 x PVIFA ( R, 48) + $1000 x PVIF (R, 48) = $43.5 x 25.267 + $1000 x 0.242 = $1341
Using Interpolation we get,
R = 3% + 7%*((960-1341)/(441-1341)) = 5.963%
Annual YTM = 2*5.963% = 11.93%
After tax cost of debt Kd = 11.93 %x ( 1- tax rate) = 11.93%x (1-34%) = 7.87%
Cost of equity:
Applying CAPM we get,
Cost of equity, Ke = Risk free rate + beta x market risk premium = 4.85% + 1.31 x 7.05% = 14.09%
Cost of preference shares:
Kp = Annual dividend / market price per share = $5.80 / $96.4 = 6.02%
Total capital
= Market value of bond + market value of equity shares+ market value of preference shares
= 10100 x $960 + 226000 x $84.60 + 13600 x $96.40
= $9696000 + $19119600 + $1311040
= $30126640
Note: While calculating the weighted-average of the returns expected by various providers of capital, market value weights for each financing element (equity, debt, etc.) must be used, because market values reflect the true economic claim of each type of financing outstanding whereas book values may not.
WACC
= weight of equity x cost of equity + weight of bond x after tax cost of bond + weight of preference shares x cost of preference shares
= (19119600/30126640) x 14.09% + (9696000/30126640) x 7.87% + (1311040/30126640) x 6.02%
= 11.74%
Rate Market Value 10% 441 R 960 3% 1341