Question

Masterson, INC., has 7 million shares of common stock outstanding. The current share price is $83, and the book value per share is $8. The company also has two bond issues outstanding. The first bond issue has a face value os $140 million, has a coupon rate of 6 percent, and sells for 94 percent of par. The second issue has a face value of $125 million, has a coupon rate of 5 percent, and sells for 105 percent of par. The first issue matures in 25 years, the second in 8 years. Both bonds make semiannual coupon payments.

a. What are the company's capital structure weights on a book value basis?

b.What are the company's capital structure weights on a market value basis?

c.Which are more relevant, the book or market value weights?

Answer 1

a. The company's capital structure weights on a book value basis is computed as shown below:

Book value of equity is computed as follows:

= 7,000,000 x $8

= $ 56,000,000

Book value of debt is computed as follows:

= $ 140,000,000 + $ 125,000,000

= $ 265,000,000

So, the total value of the company is:

= $ 56,000,000 + $ 265,000,000

= $ 321,000,000

So, the book value weights of equity and debt are:

Book value weight of equity will be

= Book value of equity / Total value of firm

= $ 56,000,000 / $ 321,000,000

= 0.1745 Approximately

Book value weight of debt will be

= 1 - Book value weight of equity

= 1 - 0.1745

= 0.8255

b. The company's capital structure weights on a market value basis is computed as shown below:

Market value of equity is computed as follows:

= 7,000,000 x $ 83

= $ 581,000,000

Market value of debt is computed as follows:

= $ 140,000,000 x 0.94 + $ 125,000,000 x 1.05

= $ 262,850,000

So, the total value of the company is:

= $ 581,000,000 + $ 262,850,000

= $ 843,850,000

So, the market value weights of equity and debt are:
Market value weight of equity will be

= Market value of equity / Total value of firm

= $ 581,000,000 / $ 843,850,000

= 0.6885 Approximately

Market value weight of debt will be

= 1 - Market value weight of equity

= 1 - 0.6885

= 0.3115

c. The market value weights are more relevant because they represent current value of the debt and equity.

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