Information on Janicek Power Co., is shown below. Assume the company’s tax rate
ID: 2764334 • Letter: I
Question
Information on Janicek Power Co., is shown below. Assume the company’s tax rate is 35 percent.
Debt: 10,000 8.6 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 96.5 percent of par; the bonds make semiannual payments.
Common stock: 225,000 shares outstanding, selling for $84.5 per share; beta is 1.30.
Preferred stock: 13,500 shares of 5.75 percent preferred stock outstanding, currently selling for $96.5 per share.
Market: 7.00 percent market risk premium and 4.80 percent risk-free rate.
Calculate the WACC
Explanation / Answer
Solution:
Calculation of WACC:
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 = 10,000 * (1,000 * 96.5%)
= 10,000 * 965
= 9,650,000
Market value of common stock = 225,000 * 84.5
= 19,012,500
Market value of preferred stock = 13,500 * 96.5
= 1,302,750
Total market value of firm = Market value of debt +Market value of common stock + Market value of preferred stock
= 9,650,000 + 19,012,500 + 1,302,750
= 29,965,250
Market value weight of Debt (WD) = Market value of debt / Total market value of firm
= 9,650,000/ 29,965,250
= 0.3220
Market value weight of Common Stock (WE) = Market value of common stock / Total market value of firm
= 19,012,500/ 29,965,250
= 0.6345
Market value weight of Preferred Stock (WP) = Market value of preferred stock / Total market value of firm
= 1,302,750/ 29,965,250
= 0.0435
Before tax Cost of Debt (KD before tax) =
Face value =1,000; Bond price = 965; Coupon rate = 8.6%; Years to maturity = 25
Using interpolation, R = 4.47%
Annual before tax cost of debt = 4.47% x 2
= 8.94%
After tax cost of debt (KDafter tax) = 8.94% x (1 – 0.35)
= 5.811
Using CAPM, Cost of Equity (KE) = Risk free rate + (Beta x Market Risk Premium)
= 4.80% + (1.30 * 7.00%)
= 13.9%
Cost of Preferred Stock (KP) = Annual dividend / Current market price
= 5.75/ 96.5
= 5.9585%
Finally, WACC will be calculated as below:
KWACC = (0.6345 x 0.1390) + (0.3220 x 0.05811) + (0.0435 x 0.059585)
= 0.0881955 + 0.0187114 + 0.0025919
= 0.1094989
= 10.95%
Hence, WACC is 10.95%