1) A company has 3,000 shares of common stock outstanding at a price of $27 per...

1) A company has 3,000 shares of common stock outstanding at a price of $27 per share. It also has 150 bonds outstanding, each with a face value of $1,000 and currently selling at 45% of face value. The tax rate is 20%. What is the weight of debt that would be used in the calculation of the weighted average cost of capital?

2) A company has equity with a market value of $15,000 and debt with a market value of $9,500. The company also has 200 shares of preferred stock that pay a constant annual dividend per share of $2.65 forever; the next dividend is in one year. The cost of the preferred stock is 8%. What is the weight of the preferred stock that would be used in the calculation of the weighted average cost of capital?

Expert Solution

Answer to Question 1:

Market Value of Common Stock = Number of Shares * Price per share
Market Value of Common Stock = 3,000 * $27
Market Value of Common Stock = $81,000

Current Price per bond = 45% * Face Value per bond
Current Price per bond = 45% * $1,000
Current Price per bond = $450

Market Value of Debt = Number of Bonds * Current Price per bond
Market Value of Debt = 150 * $450
Market Value of Debt = $67,500

Market Value of Firm = Market Value of Debt + Market Value of Common Stock
Market Value of Firm = $67,500 + $81,000
Market Value of Firm = $148,500

Weight of Debt = Market Value of Debt / Market Value of Firm
Weight of Debt = $67,500 / $148,500
Weight of Debt = 0.4545 or 45.45%

Answer to Question 2:

Market Value of Common Stock = $15,000
Market Value of Debt = $9,500

Current Price per preferred stock = Annual Dividend / Cost of Preferred Stock
Current Price per preferred stock = $2.65 / 0.08
Current Price per preferred stock = $33.125

Market Value of Preferred Stock = Number of preferred stock * Current Price per preferred stock
Market Value of Preferred Stock = 200 * $33.125
Market Value of Preferred Stock = $6,625

Market Value of Firm = Market Value of Debt + Market Value of Preferred Stock + Market Value of Common Stock
Market Value of Firm = $9,500 + $6,625 + $15,000
Market Value of Firm = $31,125

Weight of Preferred Stock = Market Value of Preferred Stock / Market Value of Firm
Weight of Preferred Stock = $6,625 / $31,125
Weight of Preferred Stock = 0.2129 or 21.29%

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