Question

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 $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 $2e.e $ 3.0 3.0 Cash and short-term securities Accounts receivable Inventories Plant and equipment BOOK-VALUE BALANCE SHEET (Figures in S millions) Liabilities and Net Worth Bonds, coupon = 5%, paid annually (maturity - 10 years, current yield to maturity = 7%) Preferred stock (par value $20 per share) Common stock (par value 50.10) Additional paid-in stockholders' equity Retained earnings Total 7. 25. $38.e Total a. What is the market debt-to-value ratio of the firm?

Answer 1

Both the answers worked out by you are correct. Please see my solution below step by step.

The solutions have been highlighted in yellow colored cells. All financials are in $ mn.

I am surprised why there is a cross mark against the value of WACC.

WACC is indeed 9.89%.

Please check up to what decimal places you have to input your answer in the box. The picture is half cut and hence I am not able to figure out the number of decimal places, you have to round your final answer up to. The only reason for error can be the rounding off. Otherwise I have found your calculation to be in order.

Market value of debt = -PV (Rate, Nper, PMT, FV) = -PV (7%, 10, 5% x 20, 20)	17.19
Market value of preferred stock = Share price x nos. of shares = Share price x Book value / par value per share	2.25
Market value of common stock = number x price = 10 x 4 =	40.00
Total capital (Sum of the above three)	59.44
Part (a) The market debt to value ratio, Wd = 17.19 / 59.44 =	28.92%
Cost of debt, Kd = YTM =	7%
Tax rate, T	21%
Cost of preferred stock, Ks = Dividend / Price = 3 / 15 =	20%
Cost of common stock, Ke = Risk free rate + Beta x Market risk premium = 4% + 0.9 x 8% =	11.200%
Preferred stock market to value ratio, Ws = 2.25 / 59.44 =	3.79%
Common stock market to value ratio, We = 40 / 59.44 =	67.29%
Part (b) WACC = Wd x Kd x (1 - T) + Ws x Ks + We x Ke	9.89%