Debt: 10,300 7.3 percent coupon bonds outstanding, with 22 years to maturity and

Question

Debt: 10,300 7.3 percent coupon bonds outstanding, with 22 years to maturity and a quoted price of 107.25. These bonds pay interest semiannually.

Common stock: 290,000 shares of common stock selling for $65.80 per share. The stock has a beta of .98 and will pay a dividend of $4.00 next year. The dividend is expected to grow by 5.3 percent per year indefinitely.

Preferred stock: 9,300 shares of 4.65 percent preferred stock selling at $95.30 per share.

Market: A 10.7 percent expected return, a risk-free rate of 5.3 percent, and a 38 percent tax rate.

Required: Calculate the WACC for Parrothead Enterprises

Explanation / Answer

Required rate of return of stock = Rf + A (Rm - Rf) Rf = Risk free rate of return = 5.3% Rm = Market rate of return = 10.7% A = beta of Stock = 0.98 Required rate of return of common stock = 5.3% + 0.98 (10.7% - 5.3%) = 10.59% After tax Cost of bonds = 7.3% * (1-tax rate) = 0.073 * (1-0.38) = 0.04526 i.e.4.53% Cost of preferred stock = 10.7% Calculation of WACC for Parrothead Enterprises Market Value Weightage Cost % Multiplication W R W * R Coupon bonds (10300 * 107.25) 1104675                            0.05 4.53% 0.24% Common stock (290000 * 65.80) 19082000                            0.91 10.59% 9.59% Preferred stock (9300 * 95.30) 886290                            0.04 10.70% 0.45% 21072965 1 10.28% WACC = 10.28%

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