Information on Janicek Power Co., is shown below. Assume the companys tax rate i
ID: 2627611 • Letter: I
Question
Information on Janicek Power Co., is shown below. Assume the companys tax rate is 35 percent. Debt: 8,500 7.2 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 118 percent of par; the bonds make semiannual payments. Common stock: 225,000 shares outstanding, selling for $87 per share; beta is 1.15. Preferred stock: 15,000 shares of 4.8 percent preferred stock outstanding, currently selling for $98 per share. Market: 7 percent market risk premium and 3.1 percent risk-free rate. Required: Calculate the company's WACC. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)
Explanation / Answer
Formula used for calculation of WACC (Weighted Average Cost of Capital) is:
KWACC = (WE x KE) + (WD x KDafter tax) + (WP x KP)
In which:
KWACC = Weighted average cost of capital
WE = Market value weight of Common Stock
KE = Cost of Equity (Common stock)
WD = Market value weight of Debt
KDafter tax = After-tax cost of debt
WP = Market value weight of Preferred Stock
KP = Cost of Preferred Stock
.
Market value of debt = 8,500 x ($1,000 x 118%)
= 8,500 x $1,180
= $10,030,000
Market value of common stock = 225,000 x $87
= $19,575,000
Market value of preferred stock = 15,000 x $98
= $1,470,000
Total market value of firm = Market value of debt +Market value of common stock + Market value of preferred stock
= $10,030,000 + $19,575,000 + $1,470,000
= $31,075,000
Market value weight of Debt (WD) = Market value of debt / Total market value of firm
= $10,030,000 / $31,075,000
= 0.3228
Market value weight of Common Stock (WE) = Market value of common stock / Total market value of firm
= $19,575,000 / $31,075,000
= 0.6299
Market value weight of Preferred Stock (WP) = Market value of preferred stock / Total market value of firm
= $1,470,000 / $31,075,000
= 0.0473
Before tax Cost of Debt (KD before tax) = ($36 x A.P.V.F50 R%) + ($1,000 / (1 + R%)50)
Using interpolation (or trial rate method), R = 2.91%
Annual after before tax cost of debt = 2.91% x 2
= 5.82%
After tax cost of debt (KDafter tax) = 5.82% x (1