You are given the following information concerning Parrothead Enterprises: 10,00
ID: 2711289 • Letter: Y
Question
You are given the following information concerning Parrothead Enterprises:
10,000 7 percent coupon bonds outstanding, with 25 years to maturity and a quoted price of 106.5. These bonds pay interest semiannually.
275,000 shares of common stock selling for $65.50 per share. The stock has a beta of .95 and will pay a dividend of $3.70 next year. The dividend is expected to grow by 5 percent per year indefinitely.
Market:
A 11 percent expected return, a risk-free rate of 5 percent, and a 35 percent tax rate.
Required:
Calculate the WACC for Parrothead Enterprises.
Debt:10,000 7 percent coupon bonds outstanding, with 25 years to maturity and a quoted price of 106.5. These bonds pay interest semiannually.
Common stock:275,000 shares of common stock selling for $65.50 per share. The stock has a beta of .95 and will pay a dividend of $3.70 next year. The dividend is expected to grow by 5 percent per year indefinitely.
Preferred stock: 9,000 shares of 4.5 percent preferred stock selling at $95.00 per share.Market:
A 11 percent expected return, a risk-free rate of 5 percent, and a 35 percent tax rate.
Explanation / Answer
WACC = Ke x We + Kd × (1 – t) × Wd + Kp x Wp
Bond Price = [Par Value × Coupon Rate × ((1 (1 + r)m×n )/1)] +[ Par Value/(1 + r)m×n]
m = no. of coupons in a year
n = no. of years
$106.5 = [100 × 3.5% × ((1 (1 + r)2×25 )/1)] +[ 100/(1 + r)2*25]
R = 3.24%
YTM = 3.24*2
= 6.47%
After tax cost of debt = 6.47(1-0.35)
= 4.21%
2. Ke = D1/P +g
= 3.75/65.5 + 0.05
= 10.65%
Ke as per CAPM = Rf + (Rm – Rf)
= 0.05 + 0.95(0.11-0.05)
= 10.70%
3. Cost of Preferred stock (Kp) = 4.5/95
= 4.74%
Type
No.
Par value
Amount (no. x par value)
Weight (%)
Cost (%)
WACC
Common Stock
275,000
10
2,750,000
59.14
10.70
6.33
Preferred Stock
9,000
100
900,000
19.35
4.74
0.92
Debt
10,000
100
1,000,000
21.51
4.21
0.91
Total
294,000
4,650,000
8.16
WACC = 8.16%
Type
No.
Par value
Amount (no. x par value)
Weight (%)
Cost (%)
WACC
Common Stock
275,000
10
2,750,000
59.14
10.70
6.33
Preferred Stock
9,000
100
900,000
19.35
4.74
0.92
Debt
10,000
100
1,000,000
21.51
4.21
0.91
Total
294,000
4,650,000
8.16