A company has 9 million shares of common stock outstanding, 340,000 shares of 6 percent preferred...

A company has 9 million shares of common stock outstanding, 340,000 shares of 6 percent preferred stock outstanding, and 180,000 7.8 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $38 per share and has a beta of 1.50, the preferred stock currently sells for $88 per share, and the bonds have 20 years to maturity and sell for 119 percent of par. The market risk premium is 7.8 percent, T-bills are yielding 3 percent, and the company’s tax rate is 36 percent.

PLEASE show all steps. I will rate.

a.	What is the firm’s market value capital structure weights? (Do not round intermediate calculations. Round your answers to 4 decimal places, e.g., 0.1234.)

	Market value weight
Debt
Preferred stock
Equity

b.	If the company is evaluating a new investment project that has the same risk as its typical project, what rate should it use to discount the project’s expected future cash flows? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Discount rate

Solutions

Expert Solution

Market Value of Shares =Number of shares*Share Price = 9000000*38 = 342000000

Market Value of Preferred Shares =Number of Shares*Preferred Share Price = 340000 * 88 = 29920000

Market Value of Debt =Price of Bonds*Number of Bonds = 180,000 * 119%*1000 = 214200000

Total Market Value = 586120000 (Sum of the above 3 values)

firm’s market value capital structure weights:

Equity = 342000000/586120000 = 58.3498%

Pref. Stock = 29920000/586120000 = 5.1048%

Bonds = 214200000/586120000 = 36.5454%

Part 2:

Cost of equity =Risk Free rate+Beta*(Market return-Risk Free rate)

= 0.03 + 1.5* 0.078 = 14.7%

Cost of Preferred stock =Dividend /price

= 6%*100/88 = 6.8182 % (Assumption: As the par value of the pref. stock is not given, i have assumed it as $100.)

Coupon, C = (1000*7.8%)/2= 39

Periods, n = 20*2 =40

Price of bond, P = 119%*1000 = 1190

Using RATE function to calculate YTM = RATE (39,40,-1190,1000) = 3.1474%

Since its a semiannual YTM, so 2 *3.1474% = 6.2948% (Note: YTM can also be calculated manually, using (C + ((F-P)/n)) / ((F+P)/2) )

Discount Rate =Weight of Equity*Cost of Equity+weight of Preferred Stock*Cost of Preferred Stock+Weight of Debt*Cost of Debt*(1-Tax Rate)

=(58.3498%* 14.7%) + (5.1048% * 6.8182 %) *(36.5454%*6.2948% *(1-36%)) = 8.58%

# Please upvote, if this answer helps

jeff jeffy answered 1 year ago

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