You are given the following information concerning Parrothead Enterprises: Debt:
ID: 2721717 • Letter: Y
Question
You are given the following information concerning Parrothead Enterprises: Debt: 9,800 7.3 percent coupon bonds outstanding, with 22 years to maturity and a quoted price of 106. These bonds pay interest semiannually. Common stock: 265,000 shares of common stock selling for $65.30 per share. The stock has a beta of .93 and will pay a dividend of $3.50 next year. The dividend is expected to grow by 5.3 percent per year indefinitely. Preferred stock: 8,800 shares of 4.65 percent preferred stock selling at $94.80 per share. Market: A 11.2 percent expected return, a risk-free rate of 5.3 percent, and a 38 percent tax rate. Required: Calculate the WACC for Parrothead Enterprises.
Explanation / Answer
WACC = We re + Wp rp + Wd rd ( 1 - tc )
Total debt = 9,800 X $ 106
Total debt = $ 1,038,800
YTM of debt
Assuming a par value of $ 100
$ 106 = $ 7.3 X PVIFA r , 22 years + 100 X PVIF r, 22 years
Annual coupon payment = $ 7.30
YTM = $ 7.30 + ($ 100 - $ 106)/22 / 0.4 X 100 + 0.6 X 106
YTM = 6.78 %
Total common stock = 265,000X $ 65.30
Total common stock = $ 17,304,500
Total preferred stock = 8,800 X $ 94.80
Total preferred stock = $ 834,240
Total = $ 834,240 + $ 17,304,500 + $ 1,038,800
Total = $ 19,177,540
We = $ 17,304,500 / $ 19,177,540
We = 0.90
Wp = $ 834,240 / $ 19,177,540
Wp = 0.0435
Wd = $ 1,038,800 / $ 19,177,540
Wd = 0.0541
Expected return on equity = Rf + Beta [ Rm - Rf ]
Expected return on equity = 0.053 + 0.93 X [ 0.112 - 0.053 ]
Expected return on equity = 10.787%
WACC = 0.90 X 0.10787 + 0.0435 X 0.0465 + 0.0541 X 0.0678 X ( 1 - 0.38)
WACC = 10.138 %
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