Question

acme Services’ CFO is considering whether to take on a new project that has average risk. She has collected the following information: • The company has outstanding bonds that mature in 15 years. The bonds have a face value of $1,000, an annual coupon of 7.5%, and sell in the market today for $1150. There are 15,000 bonds outstanding.
• The risk-free rate is 3%
. • The market risk premium is 5%
. • The stock’s beta is 0.9
. • The company’s tax rate is 35%.
• The company has 100,000 shares of preferred stock with a par value of $100. These shares are currently trading at $73, and pay an annual dividend of $3.50.
• The company also has 2,250,000 common shares trading at $15. These shares last paid an annual dividend of $0.33.
What is Acme's...
a. weight of common shares
b. before tax cost of acmes debt
c. preferred shares
d. value of debt
e. weight of debt
f. firm value

Answer 1

{1}	{2}	{3}	{4} ={2}*{3}	{5}
Particulars	Price	No.	Total Value ($)	Weight
Bond	1,150	15,000	17,250,000	29.59%
Preferred Stock	73	100,000	7,300,000	12.52%
Common Shares	15	2,250,000	33,750,000	57.89%
		Total (Firm Value):	58,300,000	100%

Part-a:

Weight of common shares = 33,750,000 / 58,300,000 * 100

= 57.89%

.

.

Part-b:

Annual Coupon on Bond = 1,000*7.5% = $75

.

Let ,YTM of Bond be x.

Current Price of the Bond = Present Value of Coupons discounted at YTM + Present Value of Redemption Value discounted at YTM

Therefore,

1,150 = 75*PVIFA(x%,15) + 1,000*PVIF(x%,15)

Computing for x ,

We get x = 5.95%

.

.Therefore , YTM of Bond = 5.95%

.

.

Therefore, Before tax cost of Acmes debt = YTM of the Bond = 5.95%

.

.

Part-c:

Acme’s preferred shares (Value) =   $7,300,000

Weight of preferred shares = 7,300,000/58,300,000 * 100

= 12.52%

.

Part-d:

Value of Debt = 1,150*15,000

= $17,250,000

.

Part-e:

Weight of Debt = 17,250,000/58,300,000 * 100

= 29.59%

.

Part-f:

Firm Value = market value of common equity + market value of preferred equity + market value of debt

= 33,750,000 + 7,300,000 + 17,250,000

= $58,300,000