Question

rate 17. Calculating the WACC You are given the following information concerning Parrothead Enterprises: LO 3 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 indefinitely. 10,000 shares of 4.4 percent preferred stock selling at $86 Preferred stock share. per 11 percent expected return, risk-free rate of 3.6 percent, and a 22 percent tax rate. Market

Answer 1

Debt:

Number of bonds outstanding = 13,000
Face Value = $1,000

Current Price = 107% * $1,000
Current Price = $1,070

Value of Debt = 13,000 * $1,070
Value of Debt = $13,910,000

Annual Coupon Rate = 6.40%
Semiannual Coupon Rate = 3.20%
Semiannual Coupon = 3.20% * $1,000
Semiannual Coupon = $32

Time to Maturity = 15 years
Semiannual Period to Maturity = 30

Let Semiannual YTM be i%

$1,070 = $32 * PVIFA(i%, 30) + $1,000 * PVIF(i%, 30)

Using financial calculator:
N = 30
PV = -1070
PMT = 32
FV = 1000

I = 2.850%

Semiannual YTM = 2.850%
Annual YTM = 2 * 2.850%
Annual YTM = 5.700%

Before-tax Cost of Debt = 5.700%
After-tax Cost of Debt = 5.700% * (1 - 0.22)
After-tax Cost of Debt = 4.446%

Preferred Stock:

Number of shares outstanding = 10,000
Current Price = $86

Annual Dividend = 4.40% * $100
Annual Dividend = $4.40

Value of Preferred Stock = 10,000 * $86
Value of Preferred Stock = $860,000

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $4.40 / $86
Cost of Preferred Stock = 5.116%

Equity:

Number of shares outstanding = 345,000
Current Price = $76.50

Value of Equity = 345,000 * $76.50
Value of Equity = $26,392,500

Using CAPM:

Cost of Equity = Risk-free Rate + Beta * (Market Return - Risk-free Rate)
Cost of Equity = 3.60% + 0.90 * (11.00% - 3.60%)
Cost of Equity = 10.260%

Using DDM:

Cost of Equity = Expected Dividend / Current Price + Growth Rate
Cost of Equity = $3.80 / $76.50 + 0.05
Cost of Equity = 9.967%

Estimated Cost of Equity = (10.260% + 9.967%) / 2
Estimated Cost of Equity = 10.1135%

Value of Firm = Value of Debt + Value of Preferred Stock + Value of Equity
Value of Firm = $13,910,000 + $860,000 + $26,392,500
Value of Firm = $41,162,500

Weight of Debt = $13,910,000 / $41,162,500
Weight of Debt = 0.3379

Weight of Preferred Stock = $860,000 / $41,162,500
Weight of Preferred Stock = 0.0209

Weight of Equity = $26,392,500 / $41,162,500
Weight of Equity = 0.6412

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Preferred Stock * Cost of Preferred Stock + Weight of Equity *Cost of Equity
WACC = 0.3379 * 4.446% + 0.0209 * 5.116% + 0.6412 * 10.1135%
WACC = 8.09%