Question

You are given the following information concerning Parrothead Enterprises: Debt: 10,100 7.1 percent coupon bonds outstanding, with 24 years to maturity and a quoted price of 106.75. These bonds pay interest semiannually. Common stock: 280,000 shares of common stock selling for $65.60 per share. The stock has a beta of .96 and will pay a dividend of $3.80 next year. The dividend is expected to grow by 5.1 percent per year indefinitely. Preferred stock: 9,100 shares of 4.55 percent preferred stock selling at $95.10 per share. Market: An expected return of 10.9 percent, a risk-free rate of 5.05 percent, and a 34 percent tax rate. Calculate the WACC for Parrothead Enterprises. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

WACC %

Answer 1

Firm’s Market Value Capital Structure

Capital	Calculation	Market Value Capital Structure Weights
Debt	[$107,1,750 / 300,15,160]	0.3592
Preferred Stock	[$865,410 / 300,15,160]	0.0288
Equity	[$183,68,000 / 300,15,160]	0.6120

Market Value of each capital Structure

Debt = $107,81,750 [10,100 x $1,067.50]

Preferred Stock = $965,410 [9,100 x $95.10]

Equity = $183,68,000 [280,000 x $65.60]

Total Market Value = $3,00,15,160

After-Tax Cost of Debt

After-tax Cost of Debt

The After-tax Cost of Debt is the after-tax Yield to maturity of the Bond

The Yield to maturity of (YTM) of the Bond is calculated using financial calculator as follows (Normally, the YTM is calculated either using EXCEL Functions or by using Financial Calculator)

Variables	Financial Calculator Keys	Figure
Face Value [$1,000]	FV	1,000
Coupon Amount [$1,000 x 7.10% x ½]	PMT	35.50
Yield to Maturity [YTM]	1/Y	?
Time to Maturity [24 Years x 2]	N	48
Bond Price [-$1,067.50]	PV	-1,067.50

We need to set the above figures into the financial calculator to find out the Yield to Maturity of the Bond. After entering the above keys in the financial calculator, we get the yield to maturity (YTM) on the bond = 6.54%

After Tax Cost of Debt = Yield to maturity x (1 – Tax Rate)

= 6.54% x (1 – 0.34)

= 6.54% x 0.66

= 4.32%

Cost of Preferred Stock

Cost of Preferred Stock = [Preferred Dividend / Selling Price] x 100

= [$4.55 / 95.10] x 100

= 4.78%

Cost of Equity

Cost of Equity = Rf + Beta[Market Rate – Risk free rate]

= 5.05% + 0.96[10.90% - 5.05%]

= 10.67%

Weighted Average Cost of Capital (WACC)

Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of Preferred stock x Weight of preferred stock] + [Cost of equity x Weight of Equity]

= [4.32% x 0.3592] + [4.78% x 0.0288] + [10.67% x 0.6120]

= 1.55% + 0.14% + 6.53%

= 8.22%

“Hence, the WACC for Parrothead Enterprises would be 8.22%”