Question

tal were used as a hurdle rate? 17. Calculating the WACC You are given the following information concerning Parrothead Enterprises: Debt: 13,000 6.4 percent coupon bonds outstanding, with 15 years to maturity and a quoted price of 107. These bonds pay interest semiannually. Common stock: 345,000 shares of common stock selling for $76.50 per share. The stock has a beta of .90 and will pay a dividend of $3.80 next year. The dividend is expected to grow by 5 percent per year indefi 10,000 shares of 4.4 percent preferred stock selling at $86 per share. ely. Preferred stock: 11 percent expected return, risk-free rate of 3.6 percent, and a 22 percent tax rate. Market: Calculate the company's WACC.

Answer 1

As per CAPM

expected return = risk-free rate + beta * (expected return on the market - risk-free rate)

Expected return% = 3.6 + 0.9 * (11 - 3.6)

Expected return% = 10.26

Price = Dividend in 1 year/(cost of equity - growth rate)

76.5 = 3.8/ (Cost of equity - 0.05)

Cost of equity% = 9.97

Cost of equity = (10.26+9.97)/2 = 10.115%

MV of equity=Price of equity*number of shares outstanding

MV of equity=76.5*345000

=26392500

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=1000*13000*1.07

=13910000

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=86*10000

=860000

MV of firm = MV of Equity + MV of Bond+ MV of Preferred equity

=26392500+13910000+860000

=41162500

Weight of equity = MV of Equity/MV of firm

Weight of equity = 26392500/41162500

W(E)=0.6412

Weight of debt = MV of Bond/MV of firm

Weight of debt = 13910000/41162500

W(D)=0.3379

Weight of preferred equity = MV of preferred equity/MV of firm

Weight of preferred equity = 860000/41162500

W(PE)=0.0209

Cost of debt

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =15x2

1070 =∑ [(6.4*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^15x2

k=1

YTM = 5.6995312419

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 5.6995312419*(1-0.22)

= 4.445634368682

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 4.4/(86)*100

=5.12

WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=4.45*0.3379+10.115*0.6412+5.12*0.0209

WACC =8.1%