Question

Examine the following book-value balance sheet for University Products Inc. The preferred stock currently sells for $15 per share and pays a dividend of $3 a share. The common stock sells for $20 per share and has a beta of 0.7. There are 2 million common shares outstanding. The market risk premium is 12%, the risk-free rate is 8%, and the firm’s tax rate is 21%.

BOOK-VALUE BALANCE SHEET
(Figures in $ millions)
Assets					Liabilities and Net Worth
Cash and short-term securities	$	1.0			Bonds, coupon = 6%, paid annually (maturity = 10 years, current yield to maturity = 8%)	$	15.0
Accounts receivable		4.0			Preferred stock (par value $20 per share)		3.0
Inventories		8.0			Common stock (par value $0.10)		0.2
Plant and equipment		24.0			Additional paid-in stockholders’ equity		10.8
					Retained earnings		8.0
Total	$	37.0			Total	$	37.0

a. What is the market debt-to-value ratio of the firm? %

b. What is University’s WACC? %

(For all the requirements, do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

Answer 1

Part a: financing Bond (working 1) preferred stock =(3000000*15/20) equity (2000000*20) total market value Market value 12,986,975.58 2,250,000.00 40,000,000.00 55, 236,975.58 23.51% market debt to value ratio=De btValue 12986975.58/55236975.58 b.calculation of WACC Financing Bond preferred stock equity after tax cost market value weight WACC c=b/total d=a*c 6.32% 12,986,975.58 23.51138% 1.49% 20.00% 2,250,000.00 4.07336% 0.81% 16.40% 40,000,000.00 72.41526% 11.88% Total 55,236,975.58 WACC 14.18%

working 1: face value annual coupon = Current yield to maturity Number of payments = 15000000 6.0% 8.0 % PV of bond = PV of interest +PV of maturity PV of interest annual interest (15000000*6%) X PVIFA( 8%,10)** PV of interest 900,000.00 6.71008 6,039,073.26 PV of maturity value Par value X PVIF(8%,10)*** PV of maturity value 15,000,000.00 0.46319 6,947,902.32 PV of bond/Price of bond 12,986,975.58 6.71008 ** PVIFA(8%,10) formula (1-(1.084-10)/0.08 |(1-(1+r)^-n) / 1/1.08410) 0.46319 ***PVIF( 8%, 10) formula = 1/(1+r)^n working 2: after tax cost of Debt = 8%*(1-0.21) 6.32% cost of preferred stock (rp)=Dividend/market price=3/15 20.00% 16.40% cost of equity (re) = risk free rate +beta*market risk premium 0.08+0.7*0.12