Question

Problem 13-7 WACC (LO1) nts 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 $10 per share and has a beta of 0.9. There are 4 million common shares outstanding. The market risk premium is 8%, the risk-free rate is 4%, and the firm's tax rate is 21% Assets look $ 3.0 $20.e - Print Cash and short-term securities Accounts receivable Inventories Plant and equipment BOOK-VALUE BALANCE SHEET (Figures in 5 millions) Liabilities and Net Worth Bonds, coupon = 5%, paid annually (naturity = 10 years, current yield to maturity = 7%) Preferred stock (par value $20 per share) Common stock (par value $0.10) Additional paid-in stockholders' equity Retained earnings Total orences S . Total 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

a]

Market debt-to-value ratio = market value of debt / market value of firm.

Market value of debt is calculated using PV function in Excel :

rate = 7% (YTM of bonds)

nper = 10 (10 years to maturity with 1 annual coupon payment each year)

pmt = 20000000 * 5% (annual coupon payment = face value * coupon rate = $20 million * 5%)

fv = 20000000

PV is calculated to be $17,190,567

A1 fc C =PV(7%,10,20000000*5%,20000000) D E F B 1 ($17,190,567.38)

Market value of debt = $17,190,567.

Market value of firm = market value of debt + market value of preferred stock + market value of common stock.

market value of preferred stock = book value * price per share / par value per share.

market value of preferred stock = $3,000,000 * $15 / $20

market value of preferred stock = $2,250,000.

market value of common = book value * price per share / par value per share.

market value of common stock = $400,000 * $10 / $0.10

market value of common stock = $40,000,000.

market value of firm = $17,190,567 + $2,250,000 + $40,000,000  

market value of firm = $59,440,567.

Market debt-to-value ratio = market value of debt / market value of firm

Market debt-to-value ratio = $17,190,567 / $59,440,567

Market debt-to-value ratio = 28.92%.

b]

WACC = (weight of debt * cost of debt) + (weight of preferred stock * cost of preferred stock) + (weight of equity * cost of equity)

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

cost of debt = 7% * (1 - 21%) = 5.53%

cost of preferred stock = dividend / current price = $3 / $15 = 20%

cost of equity = risk free rate + (beta * market risk premium)

cost of equity = 4% + (0.9 * 8%) = 11.20%

weight of preferred stock = market value of preferred stock / market value of firm.

weight of preferred stock = $2,250,000 / $59,440,567

weight of preferred stock = 3.79%

weight of common stock = market value of common stock / market value of firm.

weight of common stock = $40,000,000 / $59,440,567

weight of preferred stock = 67.29%

WACC = (28.92% * 5.53%) + (3.79% * 20%) + (67.29% * 11.20%)

WACC = 9.89%

Answer 2

Problem 13-7 WACC (LO1)

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 $16 per share and has a beta of 0.7. There are 1 million common shares outstanding. The market risk premium is 8%, the risk-free rate is 4%, 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	$	2.0			Bonds, coupon = 6%, paid annually (maturity = 10 years, current yield to maturity = 7%)	$	10.0
Accounts receivable		5.0			Preferred stock (par value $10 per share)		3.0
Inventories		9.0			Common stock (par value $0.10)		0.1
Plant and equipment		22.0			Additional paid-in stockholders’ equity		8.9
					Retained earnings		16.0
Total	$	38.0			Total	$	38.0

 

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.)