Question

Bonaime, Inc., has 7.5 million shares of common stock outstanding. The current share price is $62.50, and the book value per share is $5.50. The company also has two bond issues outstanding. The first bond issue has a face value of $71.5 million, a coupon rate of 7 percent, and sells for 90.5 percent of par. The second issue has a face value of $36.5 million, a coupon rate of 8 percent, and sells for 89.5 percent of par. The first issue matures in 20 years, the second in 12 years.

a. What are the company’s capital structure weights on a book value basis? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.)
  

Book value weight of equity
Book value weight of debt

b. What are the company’s capital structure weights on a market value basis? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.)
  

Market value weight of equity
Market value weight of debt

c. Which are more relevant, the book or market value weights?
  
(Click to select) Market value weights Book value weights

Answer 1

a

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

BV of equity=5.5*7500000

=41250000

BV of Bond1=Par value*bonds outstanding*%age of par

BV of Bond1=1000*71500*1

=71500000

BV of Bond2=Par value*bonds outstanding*%age of par

BV of Bond2=1000*36500*1

=36500000

BV of firm = BV of Equity + BV of Bond1+ BV of Bond 2

=41250000+71500000+36500000

=149250000

Weight of equity = BV of Equity/BV of firm

Weight of equity = 41250000/149250000

W(E)=0.2764

Weight of debt = BV of Bond/BV of firm

Weight of debt = 108000000/149250000

W(D)=0.7236

b

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

MV of equity=62.5*7500000

=468750000

MV of Bond1=Par value*bonds outstanding*%age of par

MV of Bond1=1000*71500*0.905

=64707500

MV of Bond2=Par value*bonds outstanding*%age of par

MV of Bond2=1000*36500*0.895

=32667500

MV of firm = MV of Equity + MV of Bond1+ MV of Bond 2

=468750000+64707500+32667500

=566125000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 468750000/566125000

W(E)=0.828

Weight of debt = MV of Bond/MV of firm

Weight of debt = 97375000/566125000

W(D)=0.172

c

market value weights are more relevant as the cost of capital for debt and equity are based due to the market value of the sources of capital