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

Question

You are given the following information concerning Parrothead Enterprises: Debt: 10,400 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 $65.90 per share. The stock has a beta of .99 and will pay a dividend of $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 $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. Note: According to learnsmart the answer is not 5.93% like some other solutions suggest

Explanation / Answer

Cost

After Tax Cost of Debt 6.728%*(1-0.40) = 4.0368%

WACC

WACC is 9.97%

Cost of Equity using CAPM: RF+ Beta*(Rm-Rf) Cost of Equity using CAPM: 5.4%+ 0.99*(10.6%-5.4%) 10.548% Cost of Preferred Shares 4.70% Cost of Debt Present Value of Bond 107.5 Face Value/ Maturity Value 100 Coupon Interest 100*7.4%*(1/2) 3.70 Years to Maturity (21*2) 42 Approximate YTM under Best assumption (Coupon Interest+((MV-PV)/Remaining Life))/ ((MV+PV)/2) (3.70+((100-107.5)/42))/((100+107.5)/2) YTM semiannual= Approax 3.39% YTM Actual = 3.364% YTM Annual 3.364%*2 = 6.728% Price at 6.728% YTM is 107.50

After Tax Cost of Debt 6.728%*(1-0.40) = 4.0368%

WACC

Particulars Number Price per Market Value Weight (Market Value/21455260 Cost Weighted Cost (Weight*Cost) Debt 10400 107.5 1118000 0.052108 4.0368% 0.21% Preferred Stock 9400 95.4 896760 0.041797 4.70% 0.20% Common Stock 295000 65.9 19440500 0.906095 10.548% 9.56% Total 21455260 WACC 9.97%

WACC is 9.97%

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