10,100 7.1 percent coupon bonds outstanding, with 24 years to maturity and a quo

Question

10,100 7.1 percent coupon bonds outstanding, with 24 years to maturity and a quoted price of 106.75. These bonds pay interest semiannually.

280,000 shares of common stock selling for $65.60 per share. The stock has a beta of .96 and will pay a dividend of $3.80 next year. The dividend is expected to grow by 5.1 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

Answer

1)

2)

WACC = 8.35%

Working

Step 1:

1)

As per CAPM

Cost of Common Stock = Rf + (Rm-Rf)*Beta

Cost of Common Stock = 5.1 + (10.9-5.1)*0.96

Cost of Common Stock = 10.67%

As per Dividend Discount Model

Cost of equity   = D1/Share Price + g

Cost of equity = 3.80/65.60 + 5.1%

Cost of equity  = 10.89%

The most relevant Cost of Equity is based on Dividend discount model , i.e 10.89%

2) Cost of Preferred Stock = 4.55/95.10

Cost of Preferred Stock = 4.78%

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

Before Tax Cost of Debt = rate(48,35.5,-1067.50,1000) * 2

Before Tax Cost of Debt = 6.54 %

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

After Tax Cost of Debt = 6.54*(1-34%)

After Tax Cost of Debt = 4.32%

Step 2:

Market Value of Common Stock = 280000*65.60 = $ 18,368,000

Market value of Preferred Stock = 9100*95.10 = $ 865410

Market Value of Bond = 10100*1000*106.75% = $ 10781750

Total Market Value = 30015160

Weight of Common Stock = 18,368,000/ 30015160 = 61.1957%

Weight of Preferred Stock = 865410/ 30015160 = 2.8833%

Weight of Debt = 10781750/ 30015160 = 35.9210%

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 = 61.1957%*10.89 + 2.8833%*4.78 + 35.9210%*4.32

WACC = 8.35%

Aftertax cost of debt 4.32%   Cost of preferred stock 4.78%   Cost of equity   10.89%

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