Question

Organic Produce Corporation has 8.4 million shares of common stock outstanding, 590,000 shares of 7.4 percent preferred stock outstanding, and 184,000 of 8.6 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $64.90 per share and has a beta of 1.29, the preferred stock currently sells for $107.10 per share, and the bonds have 13 years to maturity and sell for 91.5 percent of par. The market risk premium is 7 percent, T-bills are yielding 5.7 percent, and the firm’s tax rate is 35 percent.

Required:
	What is the firm's market value capital structure? (Do not round intermediate calculations. 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

What is the firm's cost of each form of financing? (Do not round intermediate calculations. Enter your answers as a percentage rounded to 2 decimal places (e.g., 32.16).)

	Aftertax cost of debt	%
	Cost of preferred stock	%
	Cost of equity	%

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. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Weighted average cost of capital

%

Answer 1

Number of share outstanding = 8.40 million

Share price = $64.90

Market value of equity = 8.40 × $64.90

= $545.16 million.

Market value of equity is $545.16 million.

Market value of preferred stock = 590,000 × $107.10

= $63.19 million

Market value of preferred stock is $63.19 million.

Market value of debt = 184,000 × $1,000 × 91.5%

= $168.36 million.

Market value of debt is $168.36 million.

Market value of total capital = $545.16 + $63.19 + $168.36

= $776.71 million.

Market value of total capital is $776.71 million.

Weight of equity = $545.16 / $776.71

= 70.19%

Weight of preferred stock = $63.19 / $776.71

= 8.14%

Weight of debt = $168.36 / $776.71

= 21.68%.

b.

Before tax cost of debt is calculated in excel and screen shot provided below:

Before tax cost of debt is 9.77%.

tax rate = 35%

After tax cost of debt = 9.77% × (1 - 35%)

= 6.35%

After tax cost of debt is 6.35%.

Cost of preferred stock = $7.40 / $107.10

= 6.91%

Cost of preferred stock is 6.91%.

Cost of equity = 5.70% + (7.00% × 1.29)

= 5.70% + 9.03%

= 14.73%

Cost of equity is 14.73%

Now, Discount rate that is WACC of company is calculated below:

WACC = (21.68% × 6.35%) + (8.14% × 6.91%) + (70.19% × 14.73%)

= 1.38% + 0.56% + 10.34%

= 12.28%

Discount rate that is WACC of company is 12.28%.