You are given the following information concerning Parrothead Enterprises: Debt:
ID: 2724935 • Letter: Y
Question
You are given the following information concerning Parrothead Enterprises: Debt:. 10.403 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 dollar 65.90 per share. The stock has a beta of.99 and will pay a dividend of dollar 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 dollar 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. (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)Explanation / Answer
Weight of capital is calculated as under
Cost of debt = Interest rate (1-tax) = 7.4 * (1-.4) = 4.44%
Preferred stock cost = 4.7%
Cost of equity =
Price of a stock = Di / (ke-g)
65.90 = 4.10 / (ke-.054)
65.90ke - 3.56 = 4.10
65.90ke = 7.66
ke = 11.62%
WACC = (Cost of debt*Weight of debt) + (Cost of equity * weight of equity) + (cost of preferred stock * weight of preferred stock)
= (4.44*.05) + (4.7*.04) + (11.62*.91) = 10.96%
If CAPM method for measuring cost of equity is used, then ke will be
rf + Beta ( Rm - Rf)
5.4 + .99(10.6-5.4) = 10.55%
If 10.55% is considered as cost of common stock, then WACC will be
.23 + .2 + (10.55*.91) = 10.03%
The difference in calculation of cost of equity will give different WACC
Capital Market Value Weight 10400 Bonds 1118000 0.05 Preferred Stock 896760 0.04 Common Stock 19440500 0.91 21455260 1.00Related Questions
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