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 $20 per share and has a beta of 0.7. There are 2 million common shares outstanding. The market risk premium is 12%, the risk-free rate is 8%, 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 | $ | 1.0 | Bonds, coupon = 6%, paid annually (maturity = 10 years, current yield to maturity = 8%) |
$ | 15.0 | |||
Accounts receivable | 4.0 | Preferred stock (par value $20 per share) | 3.0 | |||||
Inventories | 8.0 | Common stock (par value $0.10) | 0.2 | |||||
Plant and equipment | 24.0 | Additional paid-in stockholders’ equity | 10.8 | |||||
Retained earnings | 8.0 | |||||||
Total | $ | 37.0 | Total | $ | 37.0 |
a. What is the market debt-to-value ratio of the firm? I know the answer for this part which is 23.51%
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.)
Bonds (A) | 15 | ||||
Preferred Stock (B) | 3 | ||||
Common stock | 0.2 | ||||
Additional paid-in stockholders’ equity | 10.8 | ||||
Retained earnings | 8 | ||||
Shareholders Equity Capital (C) | 19 | ||||
Total Capital (A+B+C) | 37 | ||||
Source of capital | Formula for cost of capital | Cost of Capital | Capital amount ($ millions) | % weightage | weightage * cost |
Bonds | Cost of debt (Post tax) = Pre-tax interest rate * (1- tax rate) | 6%*(1-0.21)=4.74% | 15 | 15/37 = 40.5405% | 40.5405% * 4.74% = 1.9216% |
Preferred stock | Cost of preferred stock = Dividend per share / Par value per share | 3/20 = 15% | 3 | 3/37 = 8.1081% | 8.1081% * 15% = 1.2162% |
Equity stock | Cost of equity = Risk free rate + Beta * (market premium) | 8%+(0.7*12%) = 16.4% | 19 | 19/37 = 51.3514% | 51.3514% * 16.4% = 8.4216% |
WACC | = 1.9216% + 1.2162% + 8.4216% | ||||
WACC | = 11.56% |
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