Question

You are given the following information concerning Parrothead Enterprises:

Debt:		10,400 7.4 percent coupon bonds outstanding, with 21 years to maturity and a quoted price of 107.50. These bonds pay interest semiannually.
Common stock:		295,000 shares of common stock selling for $65.90 per share. The stock has a beta of .99 and will pay a dividend of $4.10 next year. The dividend is expected to grow by 5.4 percent per year indefinitely.
Preferred stock:		9,400 shares of 4.70 percent preferred stock selling at $95.40 per share.
Market:		An expected return of 10.6 percent, a risk-free rate of 5.20 percent, and a 40 percent tax rate.

What is the firm's cost of each form of financing? (Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Aftertax cost of debt	%
Cost of preferred stock	%
Cost of equity	%

Calculate the WACC for the company. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

WACC             %

Answer 1

a.

Par value of bond = $1,000

Market value = 107.50% of Par value

= 107.50 × $1,000

= $1,075

Market value of bond is $1,075.

YTM that is before tax cost of debt is calculated in excel and screen shot provided below:

YTM of bond is 6.73%

tax rate = 40%

After tax cost of debt = 6.73% × (1 - 40%)

= 4.04%

After tax cost of debt is 4.04%.

b.

Cost of preferred stock = Annual Dividend / Current Market price

= $4.70 / $95.40

= 4.93%

Cost of preferred stock is 4.93%.

c.

Cost of equity is calculated below using CAPM model:

Cost of equity = 5.20% + (10.60% - 5.20%) × 0.99

= 5.20% + (5.40% × 0.99)

= 5.20% + 5.35%

= 10.55%

Cost of equity is 10.55%.

Market value of total debt = 10,400 × $1,000 × 107.50%

= $11,180,000

Market value of preferred stock = 9,400 × $95.40

= $896,760

Market value of equity = 295,000 × $65.90

= $19,440,500.

Total value of capital = $11,180,000 + $896,760 + $1,440,500

= $31,570,260

Total Value of capital is $31,570,260.

Weight of debt = $11,180,000 /  $31,570,260

= 35.47%

Weight of preferred stock = $896,750 /  $31,570,260

= 2.85%

Weight of equity = $19,440,500 / $31,570,260

= 61.68%.

Now,

WACC is calculated below:

WACC = (35.47% × 4.04%) + (2.85% × 4.93%) + (61.68% × 10.55%)

= 1.43% + 0.14% + 6.51%

= 8.08%

WACC of company is 8.08%.