Question

Hankins Corporation has 7.6 million shares of common stock outstanding, 510,000 shares of 7.1 percent preferred stock outstanding, and 176,000 of 8.3 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $64.10 per share and has a beta of 1.21, the preferred stock currently sells for $107.90 per share, and the bonds have 16 years to maturity and sell for 95.5 percent of par. The market risk premium is 6.85 percent, T-bills are yielding 5.55 percent, and the firm’s tax rate is 30 percent.

a. What is the firm's market value capital structure? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.)
  

Market value weight of debt
Market value weight of preferred stock
Market value weight of equity

b. If the firm is evaluating a new investment project that has the same risk as the firm’s typical project, what rate should the firm use to discount the project’s cash flows? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
Weighted average cost of capital             %

Answer 1

Market value of common stock = 7,600,000 * 64.1 = 487,160,000

Market value of Preferred stock = 510,000 * 107.9 = 55,029,000

Market value of debt = 176,000 * ( 95.5% of 1000) = 168,080,000

Total market valur of capital structure = 487,160,000 + 55,029,000 + 168,080,000 = $710,269,000

Market value weight of debt = 168,080,000 / 710,269,000 = 0.2366

Market value weight of preferred stock = 55,029,000 / 710,269,000 = 0.0775

Market value weight of equity = 487,160,000 / 710,269,000 = 0.6859

b)

Cost of preferred stock = 7.1%

Cost of equity using CAPM method = risk free rate + beta ( amrket risk premium)

Cost of equity = 0.0555 + 1.21 ( 0.0685)

Cost of equity = 0.138385 or 13.8385%

Price of bond = 95.5% of 1,000 = $955

Coupon payment = 0.083 * 1000 = 83 / 2 = 41.5 ( since it is a semi annual bond, we divide by 2)

Number of periods = 16 * 2 = 32

Before tax cost of debt using a financial calculator = 8.83%

Keys to use in a financial calculator: 2nd I/Y 2, FV = 1000, PV = -955, N = 32, PMT = 41.5, CPT I/Y

After tax cost of debt = 0.0883 ( 1 - 0.3)

After tax cost of debt = 0.06181 or 6.181%

Weighted average cost of capital = Weigth of equity * cost of equity + weight of debt * cost of debt + weight of preferred stock * cost of preferred stock

Weighted average cost of capital = 0.6859 * 0.138385 + 0.2366 * 0.06181 + 0.0775 * 0.071

Weighted average cost of capital = 0.094918 + 0.014624 + 0.005503

Weighted average cost of capital = 0.115045 or 11.50%