You are given the following information concerning Parrothead Enterprises: Debt:

Question

You are given the following information concerning Parrothead Enterprises:

Debt: 9,600 7.1 percent coupon bonds outstanding, with 24 years to maturity and a quoted price of 105.5. These bonds pay interest semiannually.

Common Stock: 255,000 shares of common stock selling for $65.10 per share. The stock has a beta of .91 and will pay a dividend of $3.30 next year. The dividend is expected to grow by 5.1 percent per year indefinitely.

Preferred Stock: 8,600 shares of 4.55 percent preferred stock selling at $94.60 per share.

Market: A 11.4 percent expected return, a risk-free rate of 5.1 percent, and a 34 percent tax rate.

a) What is the firm's cost of each form of financing? (After tax cost of debt, cost of preferred debt, cost of equity)

b) Calculate the WACC for Parrothead Enterprises.

Explanation / Answer

cost of debt = [Interest (1- tax)+ c.v -m.p/n ]/ [c.v. + m.v / 2]= {3.55* (1-.34) + (105.5-100/48)} / {105.5+100/2} = 4.686 = 2.4%

Common stock = D1 / p0 + g

= 3.3 (1+0.051) / 65.1 + .051

= 10.43 %

Cost of preferred stock = 39130/813560= 4.81 %

cost of equity = Risk free + beta * (Market rate - risk free return)

= 5.1 + .91 (11.4 - 5.1) = 10.83 %

WACC for Parrothead Enterprises= cost of debt* Weight of debt + cost of equity * weight of eqity+ cost of preferred stock * weight of preferred stock

= 2.4* 960000/ 4370000 + 4.81* 860000/ 4370000 + 10.83* 2550000 / 4370000 = 7.31 %

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