Question

You are given the following information on Parrothead Enterprises: Debt: 8,400 7 percent coupon bonds outstanding, with 25 years to maturity and a quoted price of 106.5. These bonds pay interest semiannually and have a par value of $2,000. Common stock: 275,000 shares of common stock selling for $65.50 per share. The stock has a beta of 1.04 and will pay a dividend of $3.70 next year. The dividend is expected to grow by 5 percent per year indefinitely Preferred stock: 9,000 shares of 4.5 percent preferred stock selling at $95.00 per share. The par value is $100 per share. Market: 11 percent expected return, risk-free rate of 4.1 percent, and a 25 percent tax rate. Calculate the company's WACC. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g. 32.16.) WACC

Answer 1

Debt Face value of bond = $2.000 Current price of bond = Face value * 106.5% = $2,130 Term = 25 Years * 2 = 50 Periods Coupon rate = 7% * 6/12 = 3.5% Per period Coupon amount = Face value * Coupon rate = $2,000 * 3.5% = $70 Per period YTM of bond = [Coupon amount + (Maturity value - Current price ) / Term ]/[0.6 * Current price +0.4*Maturity value] = [$70 + ($2,000 - $2,130)/50 ]/[0.6 *$2,130 +0.4*$2,000 ] = $67.4 / $2.078 = 0.032435034 = 3.2435034 % Per period YTM = 3.2435034 % Per period * 2 = 6.4870068 % Per annum = 6.487 % Per annum (Rounded) After tax cost of debt, Kd = 6.487 %*(1 - 25%) = 4.86525 % Per annum Total market value of bonds = 8,400 bonds * $2,130 Per bond = $17,892,000

Common stock Beta of stock = 1.04 Risk free rate. Rf = 4.1% Market return, Rm = 11 % Cost of common stock, Kc = Rf + Beta * (Rm - Rf) = 4.1 % + 1.04 * ( 11% - 4.1%) = 11.276 % Current price of stock, PO = $65.50 Expected dividend, D1 = $3.70 Growth rate, g = 5% Cost of common stock equity = D1 /PO) + g = ($3.70 / $65.50) + 5% = 0.05648855 + 0.05 = 0.10648855 = 10.648855 % Average cost of equity. Ke = (11.276% + 10.648855%)/2 = 21.924855 %/2 = 10.9624275 % Market value of common stock = 275,000 shares * $65.50 = $18.012,500 Preferred stock Preferred stock dividend = $100 * 4.5% = $4.5 Current price of preferred stock = $95 Total market value of preferred stock = 9,000 Shares * $95 Per share = $855,000 Cost of preferred stock, Kp = Annual dividend / Current price = $4.5/$95 = 0.047368421 = 4.7368421 %

Total market value of firm = $17,892,000+ $18.012,500 + $855,000 = $36.759.500 Weight of debt, wd = $17,892.000 / $36,759,500 = 0.486731321 Weight of common stock, Wc = $18,012,500 / $36,759,500 = 0.490009385 Weight of preferred stock, Wp = $855,000 / $36,759,500 = 0.023259294 WACC = wd* Kd+Wc* Kc + Wp * Kp = 0.486731321 * 4.86525 % +0.490009385 * 10.9624275 % + 0.023259294 * 4.7368421 % = 7.849937522% = 7.85 % (Rounded) Ans : WACC = 7.85%