Question

A company has 10.1 million shares of common stock outstanding, 450,000 shares of 5 percent preferred stock outstanding, and 235,000 8.9 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $49 per share and has a beta of 1.55, the preferred stock currently sells for $99 per share, and the bonds have 15 years to maturity and sell for 116 percent of par. The market risk premium is 8.9 percent, T-bills are yielding 4 percent, and the company's tax rate is 38 percent. 1 polnts 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

MV of equity=Price of equity*number of shares outstanding

MV of equity=49*10100000

=494900000

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=1000*235000*1.16

=272600000

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=99*450000

=44550000

MV of firm = MV of Equity + MV of Bond+ MV of Preferred equity

=494900000+272600000+44550000

=812050000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 494900000/812050000

W(E)=0.6094

Weight of debt = MV of Bond/MV of firm

Weight of debt = 272600000/812050000

W(D)=0.3357

Weight of preferred equity = MV of preferred equity/MV of firm

Weight of preferred equity = 44550000/812050000

W(PE)=0.0549

b

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 4 + 1.55 * (8.9)

Cost of equity% = 17.8

Cost of debt

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =15x2

1160 =∑ [(8.9*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^15x2

k=1

YTM = 7.1443486983

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 7.1443486983*(1-0.38)

= 4.429496192946

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 5/(99)*100

=5.05

WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=4.43*0.3357+17.8*0.6094+5.05*0.0549

WACC =12.61%