Question

Problem 12-17 Calculating the WACC [LO 3] You are given the following information concerning Parrothead Enterprises: Debt: 8,500 7.1 percent coupon bonds outstanding, with 24 years to maturity and a quoted price of 106.75. These bonds have a par value of $2,000 and pay interest semiannually. Common stock: 280,000 shares of common stock selling for $65.60 per share. The stock has a beta of 1.06 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: 10.9 percent expected return, a risk-free rate of 4.15 percent, and a 21 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.) Loading... 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.

Answer 1

Answer:
Debt:
Number of bonds outstanding = 8,500
Face Value = $2,000
Current Price = 106.75%*$2,000 = $2,135

Value of Debt = 8,500 * $2,135
Value of Debt = $18,147,500

Annual Coupon Rate = 7.10%
Semiannual Coupon Rate = 3.55%
Semiannual Coupon = 3.55% * $2,000 = $71

Time to Maturity = 24 years
Semiannual Period to Maturity = 48

Let semiannual YTM be i%

$2,135 = $71 * PVIFA(i%, 48) + $2,000 * PVIF(i%, 48)

Using financial calculator:
N = 48
PV = -2135
PMT = 71
FV = 2000

I = 3.27%

Semiannual YTM = 3.27%
Annual YTM = 2 * 3.27%
Annual YTM = 6.54%

Before-tax Cost of Debt = 6.54%
After-tax Cost of Debt = 6.54% * (1 - 0.21)
After-tax Cost of Debt = 5.17%

Preferred Stock:
Number of shares outstanding = 9,100
Current Price = $95.10   
Par Value = $100
Annual Dividend = 4.55%*$100 = $4.55

Value of Preferred Stock = 9,100 * $95.10
Value of Preferred Stock = $865,410

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $4.55 / $95.10
Cost of Preferred Stock = 4.78%

Equity:
Number of shares outstanding = 280,000
Current Price = $65.60

Value of Common Stock = 280,000 * $65.60
Value of Common Stock = $18,368,000

As per CAPM,
Cost of Common Equity = Risk-free Rate + Beta *(Market Return – Risk Free Rate)
Cost of Common Equity = 4.15% + 1.06 * (10.9% - 4.15%)
Cost of Common Equity = 11.305%

As per Dividend Growth rate Model,
Cost of Equity = Expected Dividend / Current Price + Growth Rate
Cost of Equity = $3.80 / $65.60 + 0.051
Cost of Equity = 10.893%

Average Cost of Equity = (11.305% + 10.893%) / 2
Average Cost of Equity = 11.10%

Value of Firm = Value of Debt + Value of Preferred Stock + Value of Common Stock
Value of Firm = $18,147,500 + $865,410 + $18,368,000
Value of Firm = $37,380,910

Weight of Debt = $18,147,500/ $37,380,910
Weight of Debt = 0.4854

Weight of Preferred Stock = $865,410 / $37,380,910
Weight of Preferred Stock = 0.0232

Weight of Common Stock = $18,368,000 / $37,380,910
Weight of Common Stock = 0.4914

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 = (0.4854*5.17%) + (0.0232*4.78%) + (0.4914*11.10%)
WACC = 8.07%