10,500 7 percent coupon bonds outstanding, with 25 years to maturity and a quote
ID: 2765589 • Letter: 1
Question
10,500 7 percent coupon bonds outstanding, with 25 years to maturity and a quoted price of 107.75. These bonds pay interest semiannually.
300,000 shares of common stock selling for $66.00 per share. The stock has a beta of 1.01 and will pay a dividend of $4.20 next year. The dividend is expected to grow by 5 percent per year indefinitely.
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).)
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).)
You are given the following information concerning Parrothead Enterprises:Explanation / Answer
Calculate the cost of each form of financing:
After tax cost of debt:
= 7% (1-0.35)
= 4.65%
Therefore, the after tax cost of debt is 4.65%.
Calculate the cost of preferred stock:
Average price = ($95.50 +$100) /2
= $97.75
Cost of preferred stock = $100 *4.5/$97.75
= 4.6034%
Assumption: it is assumed face value of preferred stock is $100 issued at discount and redeemed at par.
Calculate the cost of equity:
As per CAPM (Capital Asset Pricing Model):
Ke = Rf + (Rm-Rf)
= 5 + 1.01 (10.5 – 5)
= 10.555%
Therefore, the cost of common stock is 10.555%.
Calculate the WACC:
Portfolio
Amount
Weight of
portfolio
Cost of
portfolio
WACC
Debt (10,500 * $107.75)
$ 1,131,375
5.18
0.046500
0.240899
Common stock (300,000 *$66)
$ 19,800,000
90.67
0.105550
9.569696
Preferred stock (9500* $95.5)
$ 907,250
4.15
0.046034
0.191241
Total portfolio
$ 21,838,625
100
10.00184
Therefore, WACC is 10.00184.
Portfolio
Amount
Weight of
portfolio
Cost of
portfolio
WACC
Debt (10,500 * $107.75)
$ 1,131,375
5.18
0.046500
0.240899
Common stock (300,000 *$66)
$ 19,800,000
90.67
0.105550
9.569696
Preferred stock (9500* $95.5)
$ 907,250
4.15
0.046034
0.191241
Total portfolio
$ 21,838,625
100
10.00184
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