You are given the following information concerning Parrothead Enterprises: Debt:
ID: 2724935 • Letter: Y
Question
You are given the following information concerning Parrothead Enterprises: Debt:. 10.403 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 dollar 65.90 per share. The stock has a beta of.99 and will pay a dividend of dollar 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 dollar 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: 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).)Explanation / Answer
Weight of capital is calculated as under
Cost of debt = Interest rate (1-tax) = 7.4 * (1-.4) = 4.44%
Preferred stock cost = 4.7%
Cost of equity =
Price of a stock = Di / (ke-g)
65.90 = 4.10 / (ke-.054)
65.90ke - 3.56 = 4.10
65.90ke = 7.66
ke = 11.62%
WACC = (Cost of debt*Weight of debt) + (Cost of equity * weight of equity) + (cost of preferred stock * weight of preferred stock)
= (4.44*.05) + (4.7*.04) + (11.62*.91) = 10.96%
If CAPM method for measuring cost of equity is used, then ke will be
rf + Beta ( Rm - Rf)
5.4 + .99(10.6-5.4) = 10.55%
If 10.55% is considered as cost of common stock, then WACC will be
.23 + .2 + (10.55*.91) = 10.03%
The difference in calculation of cost of equity will give different WACC
Capital Market Value Weight 10400 Bonds 1118000 0.05 Preferred Stock 896760 0.04 Common Stock 19440500 0.91 21455260 1.00