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Hungarian Motor Works (HMW) has the following capital structure: 700,000 shares of common stock, which were...

Hungarian Motor Works (HMW) has the following capital structure:

  • 700,000 shares of common stock, which were issued at a price of $20 per share (book value), and currently trade on the capital markets at $42 per share. The company paid a dividend this year of $1.00, and HMW has a beta of 1.20
  • 50,000 shares of 5.5% preferred stock, which were issued at par of $75 (book value) and currently trade on the capital markets at $77 per share.
  • 20,000 4% semi-annual bonds were issued with a par value of $1,000 each. The bonds have 17 years to maturity and currently sell for $980.

HMW’s marginal tax rate is 30%. The market rate of return is 9.0%, and the risk-free rate is 2.0%.

  1. What is the firm’s capital structure based on market values?

  1. What is HMW’s (after-tax) cost of common stock?

  1. What is HMW’s (after-tax) cost of preferred stock?

  1. What is HMW’s (after-tax) cost of debt?

  

  1. Calculate HMW’s weighted average cost of capital.
  2. please fill in chart below

Sources of Capital

Market Value

Market Weights

Cost in %

Weighted Cost

Bonds

Preferred shares

Common shares

Weighted Average Cost of Capital (WACC)                                  =

Solutions

Expert Solution

a.The market value of common stock is :

= 7,00,000 * $42

= $294,000,00

The market value of preferred stock is :

= 50,000 * $77

= $385,0000

Market value of debt :

= 20,000 * $980

= $196,000,00

So, the market value weights are :

= $294,000,00 / ($294,000,00 + $385,0000 + $196,000,00)

= $294,000,00 / $52,850,000

= 0.5563

The weight of preference shares is :

= $385,00,00/ $52,850,000

= 0.0728

The weight of debt is :

= $196,000,00/ $52,850,000

= 0.3709

a. The cost of equity is:

Re = Rf + beta * (Rm - Rf)

= 2 + 1.2* (9% - 2%)

= 10.4%

b. The cost of preferred stock :

Rp = dividend/ price of preferred stock

= 5.5% * $75/ $77

= $4.125/ $77

= 5.36%

c. The after tax cost of debt is :

FV = $1000

PMT = $20

N = 34 YEARS

PV = ($980)

I/Y = 4.1653

So, the after tax cost of debt :

= 4.1653 * 0.7

= 2.9157%

The WACC is :

= 0.3709 * 0.0292 + 0.5563* 0.104 + 0.0728 * 0.0536

= 0.0108 + 0.0579 + 0.0039

=7.26%

So, the WACC is 7.26%

jeff jeffy answered 2 years ago
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