Question

Railsplitters, Inc. has the following information for its capital structure: Instrument: Amount Issued Current Price YTM Bond A $500 Million 100.82 4.36% Bond B $350 Million 101.36 4.49% Common Stock 42.5 Million Shares $28.21 per share E(R) Market = 8.65% B = 1.27 Expected Dividend = $1.95 Rf = 2.10% Growth Rate = 2.75% Given this information, what is the total market value of the firm? Answer in millions. $1,835 0 $2,176 $2.058 $1,937

Answer 1

Common Stock:

Rf = 2.1 %, Beta = 1.27 and E(R) = 8.65 %

Cost of Equity = ke = Rf + Beta x [E(R) - Rf] = 2.1 + 1.27 x (8.65-2.1) = 10.4185 %

Expected Dividend = D1 = $ 1.95 and Growth Rate = g = 2.75 %

Price per Share = P0 = D1 / (ke - g) = 1.95 / (0.104185 - 0.0275) = $ 25.4287 ~ $ 25.43

Number of Shares Outstanding = N = 42.5 million shares

Market Value of Equity = E = 42.5 x 25.43 = $ 1075.63 million

Bonds:

Bond A: Amount Issued = $ 500 million, Current Price = 100.82 % of Amount Issued = 1.0082 x 500 = $ 504.1 million

Bond B: Amount Issued = $ 350 million, Current Price = 101.36 % of Amount Issued = 1.0136 x 350 = $ 354.76 million

Total Debt (Bond) Market Value = D = 504.1 + 354.76 = $ 858.86 million

Total Firm Market Value = E + D = 1075.63 + 858.86 = $ 1934.49 million ~ $ 1937 million

Hence, the correct option is (d)