Question

You are given the following information on Parrothead Enterprises: Debt: 9,200 6.4 percent coupon bonds outstanding, with 23 years to maturity and a quoted price of 104.5. These bonds pay interest semiannually and have a par value of $1,000. Common stock: 235,000 shares of common stock selling for $64.70 per share. The stock has a beta of .92 and will pay a dividend of $2.90 next year. The dividend is expected to grow by 5.2 percent per year indefinitely. Preferred stock: 8,200 shares of 4.6 percent preferred stock selling at $94.20 per share. The par value is $100 per share. Market: 11.8 percent expected return, risk-free rate of 3.7 percent, and a 22 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

Answer:

Debt:

Number of bonds outstanding = 9,200
Face Value = $1,000
Current Price = 104.5% * $1,000 = $1,045

Value of Debt = 9,200 * $1,045
Value of Debt = $9,614,000

Annual Coupon Rate = 6.40%
Semiannual Coupon Rate = 3.20%
Semiannual Coupon = 3.20% * $1,000 = $32

Time to Maturity = 23 years
Semiannual Period to Maturity = 46

Let semiannual YTM be i%

$1,045 = $32 * PVIFA(i%, 46) + $1,000 * PVIF(i%, 46)

Using financial calculator:
N = 46
PV = -1045
PMT = 32
FV = 1000

I = 3.02%

Semiannual YTM = 3.02%
Annual YTM = 2 * 3.02%
Annual YTM = 6.04%

Before-tax Cost of Debt = 6.04%
After-tax Cost of Debt = 6.04% * (1 - 0.22)
After-tax Cost of Debt = 4.7112%

Preferred Stock:

Number of shares outstanding = 8,200
Current Price = $94.20
Annual Dividend = 4.60% * $100 = $4.60

Value of Preferred Stock = 8,200 * $94.20
Value of Preferred Stock = $772,440

Cost of Preferred Stock = Annual Dividend / Current Price
Cost of Preferred Stock = $4.60 / $94.20
Cost of Preferred Stock = 4.8832%

Equity:

Number of shares outstanding = 235,000
Current Price = $64.70

Value of Common Stock = 235,000 * $64.70
Value of Common Stock = $15,204,500

Using CAPM Model,
Cost of Common Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Common Equity = 3.7% + (0.92 * 11.8%)
Cost of Common Equity = 14.5560%

Using Growth Model,
Cost of Equity = D1 / P0 + g
Cost of Equity = $2.90 / $64.70 + 0.052
Cost of Equity = 9.6822%

Average Cost of Equity = (14.5560% + 9.6822%)/2
Average Cost of Equity = 12.1191%

Value of Firm = Value of Debt + Value of Preferred Stock + Value of Common Stock
Value of Firm = $9,614,000 + $772,440 + $15,204,500
Value of Firm = $25,590,940

Weight of Debt = $9,614,000 / $25,590,940
Weight of Debt = 0.3757

Weight of Preferred Stock = $772,440 / $25,590,940
Weight of Preferred Stock = 0.0302

Weight of Common Stock = $15,204,500 / $25,590,940
Weight of Common Stock = 0.5941

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 = (0.3757 * 4.7112%) + (0.0302 * 4.8832%) + (0.5941 * 12.1191%)
WACC = 9.12%