Consider the following information for Watson Power Co.: Debt: 3,500 7 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 102 percent of par; the bonds make semiannual payments. Common stock: 84,000 shares outstanding, selling for $59 per share; the beta is 1.06. Preferred stock: 10,000 shares of 6 percent preferred stock outstanding, currently selling for $104 per share. Market: 8.5 percent market risk premium and 5.5 percent risk-free rate. Assume the company's tax rate is 35 percent. Find the WACC.

9. 82 %

Explanation:

WACC = Cost of equity x Weight of equity + Cost of Preferred Stock x Weight of Preferred Stock + Cost of Debt x Weight of Debt.

Remember to always use the After tax cost of debt :

Cost of Debt :

PV = - $1,020

FV = $1,000

N = 20 x 2 = 40

P/YR = 2

PMT = ($1,000 x 7 %) ÷ 2 = $35

I/YR = ???

The Cost (I/YR) is calculated as 6.82 %. The  After tax cost of debt is 4.433 %.

Cost of Equity :

Cost of Equity = Return from risk free security + beta x market premium'

                        = 5.5 % + 1.06 x 8.5 %

                        = 14.51 %

Cost of Preferred Stock :

Cost of Preferred Stock = 6 %

therefore,

WACC = 14.51 % x 51.8 % +  6 % x 10.87 %+ 4.433 % x 37.3 %

            = 9. 82 %

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