Question

You are given the following information on Parrothead Enterprises:
Debt:	9,800 7.3 percent coupon bonds outstanding, with 22 years to maturity and a quoted price of 106. These bonds pay interest semiannually and have a par value of $1,000.
Common stock:	265,000 shares of common stock selling for $65.30 per share. The stock has a beta of .98 and will pay a dividend of $3.50 next year. The dividend is expected to grow by 5.3 percent per year indefinitely.
Preferred stock:	8,800 shares of 4.65 percent preferred stock selling at $94.80 per share. The par value is $100 per share.
Market:	11.2 percent expected return, risk-free rate of 4 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 = 9,800
Face Value = $1,000
Current Price = 106%*$1,000 = $1,060

Value of Debt = 9,800 * $1,060
Value of Debt = $10,388,000

Annual Coupon Rate = 7.3%
Semiannual Coupon Rate = 3.65%
Semiannual Coupon = 3.65%*$1,000 = $36.5

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

Let semiannual YTM be i%

$1,060 = $36.5 * PVIFA(i%, 44) + $1,000 * PVIF(i%, 44)

Using financial calculator:
N = 44
PV = -1060
PMT = 36.5
FV = 1000

I = 3.39%

Semiannual YTM = 3.39%
Annual YTM = 2 * 3.39%
Annual YTM = 6.78%

Before-tax Cost of Debt = 6.78%
After-tax Cost of Debt = 6.78% * (1 - 0.23)
After-tax Cost of Debt = 5.22%

Preferred Stock:

Number of shares outstanding = 8,800
Current Price = $94.80
Annual Dividend = 4.65%*$100 = $4.65

Value of Preferred Stock = 8,800 * $94.80
Value of Preferred Stock = $834,240

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $4.65 / $94.80
Cost of Preferred Stock = 4.91%

Equity:

Number of shares outstanding = 265,000
Current Price = $65.30

Value of Common Stock = 265,000 * $65.30
Value of Common Stock = $17,304,500

Cost of Common Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Equity = 4% + 0.98 * (11.2% - 4%)
Cost of Common Equity = 11.06%

Value of Firm = Value of Debt + Value of Preferred Stock + Value of Common Stock
Value of Firm = $10,388,000 + $834,240 + $17,304,500
Value of Firm = $28,526,740

Weight of Debt = $10,388,000/$28,526,740
Weight of Debt = 0.3642

Weight of Preferred Stock = $834,240/$28,526,740
Weight of Preferred Stock = 0.0292

Weight of Common Stock = $17,304,500/$28,526,740
Weight of Common Stock = 0.6066

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 = 0.3642*5.22% + 0.0292*4.91% + 0.6066*11.06%
WACC = 8.75%