Question

A company has 9.1 million shares of common stock outstanding, 350,000 shares of 4 percent preferred stock outstanding, and 185,000 7.9 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $39 per share and has a beta of 1.55, the preferred stock currently sells for $89 per share, and the bonds have 10 years to maturity and sell for 110 percent of par. The market risk premium is 7.9 percent, T-bills are yielding 5 percent, and the company's tax rate is 40 percent. a. What is the firm's market value capital structure weights? (Do not round intermediate calculations. Round your answers to 4 decimal places, e.g., 0.1234.) Market value weight Debt Preferred stock Equity b. If the company is evaluating a new investment project that has the same risk as its typical project, what rate should it use to discount the project's expected future cash flows? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Discount rate %

Answer 1

a. Value of Debt =Number of Bonds*Par Value*110%=185000*1000*110% =203,500,000
Value of Preferred Stock =Number of Preferred Stocks*Price =350000*89 =31,150,000
Value of Equity =Number of Shares *Price =9100000*39 =354,900,000

b. Par Value of Bond =1000
Semi annual coupon =7.9%*1000/2 =39.5
Number of Periods =2*10 =20
Price =110%*100 =1100
YTM using excel formula =2*Rate(20,39.5,-1100,1000) =6.5230%

Cost of Preferred stock =4%
Cost of Equity =Risk free Rate+Beta*Market Risk Premium =5%+1.55*7.9% =17.245%
Total value =354,900,000+31,150,000+203,500,000=589,550,000
Discount Rate =Weight of Equity*Cost of Equity+Weight of Preferred Stock*Cost of Preferred stock+Weight of Debt*Cost of Debt*(1-Tax Rate)
=354,900,000/589,550,000*17.245%+31,150,000/589,550,000*4%+203,500,000/589,550,000*6.5230%*(1-40%)=11.94%