You are given the following information concerning Parrothead Enterprises: 10,70

Question

You are given the following information concerning Parrothead Enterprises:

10,700 7.2 percent coupon bonds outstanding, with 23 years to maturity and a quoted price of 108.25. These bonds pay interest semiannually.

310,000 shares of common stock selling for $66.20 per share. The stock has a beta of 1.03 and will pay a dividend of $4.40 next year. The dividend is expected to grow by 5.2 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).)

Debt:

10,700 7.2 percent coupon bonds outstanding, with 23 years to maturity and a quoted price of 108.25. These bonds pay interest semiannually.

Common stock:

310,000 shares of common stock selling for $66.20 per share. The stock has a beta of 1.03 and will pay a dividend of $4.40 next year. The dividend is expected to grow by 5.2 percent per year indefinitely.

Preferred stock: 9,700 shares of 4.6 percent preferred stock selling at $95.70 per share. Market: A 10.3 percent expected return, a risk-free rate of 5.2 percent, and a 30 percent tax rate.

Explanation / Answer

Step 1:

1) Using CAPM

Cost of Equity = Rf + (Rm-Rf)*Beta

Cost of Equity = 5.2 + (10.3-5.2)*1.03

Cost of Equity = 10.453%

Using DDM

Cost of Equity = D1/P0 + g

Cost of Equity = 4.4/66.2 + 5.2%

Cost of Equity = 11.85%

2) Cost of Preferred Stock = 4.6/95.7

Cost of Preferred Stock = 4.81%

3) Before Tax Cost of Debt = rate(nper,pmt,pv,fv) *2

Before Tax Cost of Debt = rate(46,36,-1082.50,1000)*2

Before Tax Cost of Debt = 6.50%

After Tax Cost of Debt = Before Tax Cost of Debt *(1-tax rate)

After Tax Cost of Debt = 6.5*(1-30%)

After Tax Cost of Debt = 4.55%

Step 2:

Market Value of Common Stock = 310000*66.20 = 20,522,000

Market value of Preferred Stock = 9700*95.7 = 928,290

Market Value of Bond = 10700*1082.5 = 11,582,750

Total Market Value = $ 33,033,040

Weight of Common Stock = 20522000/33033040

Weight of Preferred Stock = 928290/33033040

Weight of Debt = 11582750/33033040

Step3:

WACC = Weight of Common Stock* Cost of Common Stock + Weight of Preferred Stock* Cost of Preferred Stock + Weight of Debt* After Tax cost of Debt

WACC = 20522000/33033040 * 10.453 + 928290/33033040 * 4.81 + 11582750/33033040*4.55

WACC = 8.22%

  Aftertax cost of debt 4.55%   Cost of preferred stock 4.81%   Cost of equity   10.45%

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