Question

You are given the following information concerning Parrothead Enterprises: Debt: 9,100 6.3 percent coupon bonds outstanding, with 24 years to maturity and a quoted price of 104.25. These bonds pay interest semiannually. Common stock: 230,000 shares of common stock selling for $64.60 per share. The stock has a beta of .86 and will pay a dividend of $2.80 next year. The dividend is expected to grow by 5.1 percent per year indefinitely. Preferred stock: 8,100 shares of 4.55 percent preferred stock selling at $94.10 per share. Market: An expected return of 11.9 percent, a risk-free rate of 5.05 percent, and a 34 percent tax rate. Calculate the WACC for Parrothead Enterprises.

Answer 1

MV of equity=Price of equity*number of shares outstanding

MV of equity=64.6*230000

=14858000

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=1000*9100*1.0425

=9486750

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=94.1*8100

=762210

MV of firm = MV of Equity + MV of Bond+ MV of Preferred equity

=14858000+9486750+762210

=25106960

Weight of equity = MV of Equity/MV of firm

Weight of equity = 14858000/25106960

W(E)=0.5918

Weight of debt = MV of Bond/MV of firm

Weight of debt = 9486750/25106960

W(D)=0.3779

Weight of preferred equity = MV of preferred equity/MV of firm

Weight of preferred equity = 762210/25106960

W(PE)=0.0304

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (expected return on the market - risk-free rate)

Cost of equity% = 5.05 + 0.86 * (11.9 - 5.05)

Cost of equity% = 10.94

Cost of debt

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =24x2

1042.5 =∑ [(6.3*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^24x2

k=1

YTM = 5.9646843832

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 5.9646843832*(1-0.34)

= 3.936691692912

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 4.55/94.1*100

=4.84

WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=3.94*0.3779+10.94*0.5918+4.84*0.0304

WACC =8.11%