Question

You are given the following information on Parrothead Enterprises:
Debt:	8,700 7.3 percent coupon bonds outstanding, with 22 years to maturity and a quoted price of 107.25. These bonds pay interest semiannually and have a par value of $2,000.
Common stock:	290,000 shares of common stock selling for $65.80 per share. The stock has a beta of 1.03 and will pay a dividend of $4.00 next year. The dividend is expected to grow by 5.3 percent per year indefinitely.
Preferred stock:	9,300 shares of 4.65 percent preferred stock selling at $95.30 per share. The par value is $100 per share.
Market:	10.7 percent expected return, risk-free rate of 4.25 percent, and a 23 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

Debt:

Number of bonds outstanding = 8,700
Face Value = $2,000

Current Price = 107.25% * $2,000
Current Price = $2,145

Value of Debt = 8,700 * $2,145
Value of Debt = $18,661,500

Annual Coupon Rate = 7.30%
Semiannual Coupon Rate = 3.65%
Semiannual Coupon = 3.65% * $2,000
Semiannual Coupon = $73

Time to Maturity = 22 years
Semiannual Period to Maturity = 44

Let Semiannual YTM be i%

$2,145 = $73 * PVIFA(i%, 44) + $2,000 * PVIF(i%, 44)

Using financial calculator:
N = 44
PV = -2145
PMT = 73
FV = 2000

I = 3.334%

Semiannual YTM = 3.334%
Annual YTM = 2 * 3.334%
Annual YTM = 6.668%

Before-tax Cost of Debt = 6.668%
After-tax Cost of Debt = 6.668% * (1 - 0.23)
After-tax Cost of Debt = 5.134%

Preferred Stock:

Number of shares outstanding = 9,300
Current Price = $95.30

Annual Dividend = 4.65% * $100
Annual Dividend = $4.65

Value of Preferred Stock = 9,300 * $95.30
Value of Preferred Stock = $886,290

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $4.65 / $95.30
Cost of Preferred Stock = 0.04879 or 4.879%

Common Stock:

Number of shares outstanding = 290,000
Current Price = $65.80

Value of Common Stock = 290,000 * $65.80
Value of Common Stock = $19,082,000

Using CAPM:

Cost of Common Stock = Risk-free Rate + Beta * (Return on Market - Risk-free Rate)
Cost of Common Stock = 4.25% + 1.03 * (10.70% - 4.25%)
Cost of Common Stock = 10.8935%

Using DDM:

Cost of Common Stock = Expected Dividend / Current Price + Growth Rate
Cost of Common Stock = $4.00 / $65.80 + 0.053
Cost of Common Stock = 0.11379 or 11.379%

Expected Cost of Common Stock = (10.8935% + 11.379%) / 2
Expected Cost of Common Stock = 11.13625%

Value of Firm = Value of Debt + Value of Preferred Stock + Value of Common Stock
Value of Firm = $18,661,500 + $886,290 + $19,082,000
Value of Firm = $38,629,790

Weight of Debt = $18,661,500 / $38,629,790
Weight of Debt = 0.4831

Weight of Preferred Stock = $886,290 / $38,629,790
Weight of Preferred Stock = 0.0229

Weight of Common Stock = $19,082,000 / $38,629,790
Weight of Common Stock = 0.4940

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Preferred Stock * Cost of Preferred Stock + Weight of Common Stock * Cost of Common Stock
WACC = 0.4831 * 5.134% + 0.0229 * 4.879% + 0.4940 * 11.13625%
WACC = 8.09%