Problem 12-18 Calculating the WACC [LO 3] You are given the following informatio
ID: 2765583 • Letter: P
Question
Problem 12-18 Calculating the WACC [LO 3] You are given the following information concerning Parrothead Enterprises: Debt: 10,800 7.3 percent coupon bonds outstanding, with 22 years to maturity and a quoted price of 108.5. These bonds pay interest semiannually. Common stock: 315,000 shares of common stock selling for $66.30 per share. The stock has a beta of 1.04 and will pay a dividend of $4.50 next year. The dividend is expected to grow by 5.3 percent per year indefinitely. Preferred stock: 9,800 shares of 4.65 percent preferred stock selling at $95.80 per share. Market: A 10.2 percent expected return, a risk-free rate of 5.3 percent, and a 38 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
We will begin by finding the market value of each type of financing. We find:
MVD = 10800($1,000)(1.085) = $11,718,000
MVE = 315000($66.30) = $20,884,500
MVP = 9800($95.80) = $938840
And the total market value of the firm is:
V = $11,718,000 + 20,884,500 + 938,840
V = $33541340
Now, we can find the cost of equity using the CAPM. The cost of equity is:
RE1 = .053 + 1.04(.102 – .053)
RE1 10.40%
We can also find the cost of equity, using the dividend discount model. The cost of equity with the dividend discount model is:
RE2 = ($4.50/$66.30) + .053
RE2 = .12.09%
Both estimates for the cost of equity seem reasonable, so we will use the average of the two. The cost of equity estimate is:
RE = (.1040 + .1209)/2
RE = 11.24%
The cost of debt is the YTM of the bonds, so:
P0 = $1,085 = $36.5(PVIFAR%,44) + $1,000(PVIFR%,44)
R = 3.282%
YTM = 3.282% × 2
YTM = 6.564%
And the after tax cost of debt is:
RD = (1 – .38)(.06564)
RD = 4.07%
The cost of preferred stock is:
RP = $4.65/$95.80
RP = 4.85%
Cost of Capital Weight WACC Commonstock 11718000 34.94% 11.24% 3.927% Debt 20884500 62.26% 4.07% 2.534% Preferred stock 938840 2.80% 4.85% 0.136% 33541340 WACC 6.597%