Question

Suppose the Schoof Company has this book value balance sheet:

Current assets		$30,000,000		Current liabilities		$20,000,000
Fixed assets		70,000,000		Notes payable		$10,000,000
				Long-term debt		30,000,000
				Common stock (1 million shares)		1,000,000
				Retained earnings		39,000,000
Total assets		$100,000,000		Total liabilities and equity		$100,000,000

The notes payable are to banks, and the interest rate on this debt is 7%, the same as the rate on new bank loans. These bank loans are not used for seasonal financing but instead are part of the company's permanent capital structure. The long-term debt consists of 30,000 bonds, each with a par value of $1,000, an annual coupon interest rate of 8%, and a 20-year maturity. The going rate of interest on new long-term debt, r_d, is 11%, and this is the present yield to maturity on the bonds. The common stock sells at a price of $56 per share. Calculate the firm's market value capital structure. Do not round intermediate calculations. Round your answers to two decimal places.

Short-term debt		$ ___________		___________ %
Long-term debt		___________		___________
Common equity		___________		___________
Total capital		$ ___________		___________ %

Answer 1

It is mentioned that notes payable are not used for seasonal financing but are part of permanent capital structure, therefore, we will consider it as long-term.

Notes payable = $10,000,000

Par value of a long term debt bond = $1000

Market Price of a bond is present value of all its remaining payments i.e. all remaining coupon payments and maturity payment

Present value of a payment = Cash flow/(1+r)ⁿ

where r is rate of interest and n is period of cash flow

Price of a bond = C/(1+r)¹ + C/(1+r)² + ..................... + C/(1+r)ⁿ + M/(1+r)ⁿ

where C is coupon rate, r is yield to maturity, and M is value at maturity

A bond always pays Face value at its maturity, therefore, in this case M = $1,000

Annual coupon rate = 8%

Coupon = 0.08*1000 = $80

Current YTM = 11%

Time to maturity = 20 years

Price = 80/(1+0.11)¹ + 80/(1+0.11)² + ............................ + 80/(1+0.11)¹⁹ + 1080/(1+0.11)²⁰

Solving this, we gets price of bond as 761.10

Market value of long term debt = 761.10*30,000 = 22,833,004.7

Common shares outstanding = 1,000,000

Market price of a share = $56

Market value of common equity = 56*1000000 = $56,000,000

As notes payable are long-term, therefore short-term debt = 0.00

Long-term debt = notes payable + market value of bonds = 10,000,000 + 22,833,004.7 = $32,833,004.69

Common equity = Market value of common equity = $56,000,000.00

Total Capital = short-term debt + long-term debt + common equity = 0 + 32,833,004.69 + 56,000,000 = $88,833,004.69

% short term debt = Short-term debt / Total capital = 0/88,833,004.69 = 0.00%

% long term debt = Long-term debt / Total capital = 32,833,004.69/88,833,004.69 = 36.96%

% common equity = common equity / Total capital = 56,000,000/88,833,004.69 = 63.04%

% Total capital = Total capital / total capital = 88,833,004.69/88,833,004.69 = 100.00%