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

Answer 1

a) To calculate the weight of common shares we will first calculate the value of all the components of capital based on market value.

We will take the present market values of all the components of the capital structure.

Particulars	Price per share/bond	Total no of shares/bond	Total market value	Weights
Common shares	15	2250000	33750000	57.89%
Bond	1150	15000	17250000	29.59%
Preferred shares	73	100000	7300000	12.52%
Total			58300000	100.00%

b) before tax cost of debt: we will use the rate formula in excel. please find the calculations below:

Particulars	Amount
Present value	1150
Coupon Payment	-75
No of years	15
Future Value/Maturity Value	-1,000.00
Interest rate	5.96%

The coupon payment and the future value will be taken as negative for calculation purposes.

The before-tax cost of debt is 5.96%.

c) Preferred shares are values at 100000 * 73 = 7,300,000

cost of preferred shares is 3.50/73 = 4.79%

it can also be calculates as 73*4.79% = 3.496 = 3.50