Question

You are given the following information on Parrothead Enterprises: Debt: 9,700 7.2 percent coupon bonds outstanding, with 23 years to maturity and a quoted price of 105.75. These bonds pay interest semiannually and have a par value of $1,000. Common stock: 260,000 shares of common stock selling for $65.20 per share. The stock has a beta of .97 and will pay a dividend of $3.40 next year. The dividend is expected to grow by 5.2 percent per year indefinitely. Preferred stock: 8,700 shares of 4.6 percent preferred stock selling at $94.70 per share. The par value is $100 per share. Market: 11.3 percent expected return, risk-free rate of 3.95 percent, and a 22 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.)

Answer 1

1]	The first step is to find the cost of the individual sources of
	capital:
	Cost of debt:
	Before tax cost of debt = YTM.
	YTM using a financial calculator = 6.71%
	[Inputs are Face value $1000, Interest 7.2% payable semi-
	annually, 23 years to maturity and Price = $1057.50]
	After tax cost of debt = 6.71%*(1-22%) =	5.23%
	Cost of common stock:
	Required return per CAPM = 3.95%+0.97*(11.3%-3.95%) =	11.08%
	Cost of common stock using constant dividend growth formula = 3.40/65.20+0.052 =	10.41%
	Average of the above two = (11.08%+10.41%)/2 =	10.75%
	Cost of preferred stock:
	=4.6/94.70 =	4.86%
2]	WACC is calculated below, using market value weights:
	Component	Market Value	Weight	Component Cost	WACC
	Debt [9700*1057.5]	$   1,02,57,750	36.59%	5.23%	1.92%
	Common stock [260000*65.20]	$   1,69,52,000	60.47%	10.75%	6.50%
	Preferred stock [8700*94.70]	$         8,23,890	2.94%	4.86%	0.14%
	Total	$   2,80,33,640	100.00%		8.56%
	WACC = 8.56%