Question

Erna Corp. has 8 million shares of common stock outstanding. The current share price is $73, and the book value per share is $7. Erna Corp. also has two bond issues outstanding. The first bond issue has a face value of $85 million, has a 7 percent coupon, and sells for 97 percent of par. The second issue has a face value of $50 million, has an 8 percent coupon, and sells for 108 percent of par. The first issue matures in 21 years, the second in 6 years.

a. What are Erna’s capital structure weights on a book value basis? (Round your answers to 4 decimal places. (e.g., 32.1616))

Equity/Value=

Debt/Value=

b. What are Erna’s capital structure weights on a market value basis? (Round your answers to 4 decimal places. (e.g., 32.1616))

Equity/Value=

Debt/Value=

c. Which are more relevant, the book or market value weights?

Market value

Book value

Answer 1

a) Book Value of Equity = Common Stock shares*Book Value per share

= 8,000,000 shares*$7 per share = $56,000,000

Book Value of Debt = Book Value of Ist Bond+Book Value of 2nd Bond

= $85,000,000+$50,000,000 = $135,000,000

Total Value = Book Value of Equity+Book Value of Debt

= $56,000,000+$135,000,000 = $191,000,000

Equity/Value = $56,000,000/$191,000,000 = 0.2932

Debt/Value = $135,000,000/$191,000,000 = 0.7068

b) Market Value of Equity = Common Stock shares*Market Price per share

= 8,000,000 shares*$73 per share = $584,000,000

Market Value of Debt = ($85,000,000*97%)+($50,000,000*108%)

= $82,450,000+$54,000,000 = $136,450,000

Total Market Value = Market Value of Equity+Market Value of Debt

= $584,000,000+$136,450,000 = $720,450,000

Equity/Value = $584,000,000/$720,450,000 = 0.8106

Debt/Value = $136,450,000/$720,450,000 = 0.1894

c) The market value weights are more relevant because they represent a more current valuation of the debt and equity.