You are given the following information concerning Parrothead Enterprises: Debt:

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 107.5. 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 4.7 percent preferred stock selling at $95.40 per share. Market: A 10.6 percent expected return, a risk-free rate of 5.4 percent, and a 40 percent tax rate. Required: What is the firm's cost of each form of financing? (Do not round intermediate calculations. Enter your answers as a percentage rounded to 2 decimal places (e.g., 32.16).) Aftertax cost of debt Cost of preferred stock Cost of equity % Calculate the WACC for Parrothead Enterprises. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).) WACC %

Explanation / Answer

WACC = equity / (equity+preference+debt) x cost of equity + preference capital /(equity+preference+debt) x cost of preference capital x debt / (equity+preference+debt) x cost of debt (1-tax)

WACC = 5.93%

Cost of Debt = (Interest Rate +((Redeemable Value - Quoted Price)/n))/( Redeemable Value +Quoted Price /2)
Interest Rate = 7.4/2 = 3.7%
Quoted Price = $107.5
Face Value = $100
Maturity (n)= 21*2 = 42
Cost of debt =(3.70+100-107.5)/42))/((107.5+100)/2)
Cost of debt = 3.39% 3.39%* 2 = 6.79%
After tax Cost of Debt = 6.79%*(1-.40) = 4.07% Assuming face value of prefered stock as $100
Dividend = 4.7% / 100 = $4.7
Cost of preferred stock = Dividend / current market price
= 4.7/ 95 = 4.95% Cost of equity capital using dividend growth model
price per share = $65.90
Dividend next year = $4.10
Growth rate = 5.4% indefinately
Cost of equity capital by dividend growth model = (Dividend / price per share)+ growth rate
=( 4.10 / 65.90) + 5.4% = 11.62% Cost of equity using CAPM method
= risk free rate of return + market beta ( expected rate - risk free rate of return
risk free rate of return = 5.4%
Expected rate = 10.6%
Market beta = .99
Cost of equity = .054 + .99 ( .106 - .054)
Cost of Equity = .054 + .99 (.052)
                    =.054 + .05148 = .10548 or 10.55% Since both the values are close we will take the average of two as cost of equity capital
= (11.62 + 10.55) / 2 = 11.08%

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