Consider the following information for Evenflow Power Co., Debt: 5,500 5.5 percent coupon bonds outstanding, $1,000 par value, 19 years to maturity, selling for 104 percent of par; the bonds make semiannual payments.
Common stock: 137,500 shares outstanding, selling for $56 per share; the beta is 1.08.
Preferred stock: 18,500 shares of 5 percent preferred stock outstanding, currently selling for $106 per share.
Market: 7.5 percent market risk premium and 4 percent risk-free rate.
Assume the company's tax rate is 31 percent.
Required:Find the WACC.

8.02 %

Explanation:

Weighted Average Cost of Capital (WACC) is the the cost required by holders of permanent source of capital pooled together.

WACC = Cost of Equity x Weight of Equity + Cost of Preferred Stock x Weight of  Preferred Stock + Cost of Debt x Weight of Debt

where,

Cost of Equity (CAPM) = 4 % + 1.08 x 7.5 %

                                     = 12.10 %

Cost of Preferred Stock = 5%

Cost of Debt :

PMT = ($1,000 x 5.5%) ÷ 2 = $27.50

N = 19 x 2 = 38

PV = $1,000 x 104 % = - $1,040

P/YR = 2

FV = $1,000

I/YR = ??

Using a Financial calculator the YTM (which is the cost of debt) is 5.17 %

But,

We use after tax cost of debt.

After tax cost of debt = 5.17 % x (1 - 0.31) = 3.57%

also

Total Market Value = $5,720,000 + $7,700,000 + $1,961,000 = $15,381,000

Weight of Equity  = 0.50

Weight of  Preferred Stock = 0.13

Weight of Debt = 0.37

therefore,

WACC = 12.10 % x 0.50 + 5% x 0.13 + 3.57% x 0.37

           = 8.02 %

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