Question

8

Hero Manufacturing has 10 million shares of common stock outstanding. The current share price is $82 and the book value per share is $5. The company also has two bond issues outstanding, both with semiannual coupons. The first bond issue has a face value $85 million and a coupon of 5 percent and sells for 97 percent of par. The second issue has a face value of $55 million and a coupon of 6 percent and sells for 105 percent of par. The first issue matures in 20 years, the second in 9 years.

a.	What are the company's capital structure weights on a book value basis? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., .1616.)
b.	What are the company's capital structure weights on a market value basis? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., .1616.)

   

c.	Which are more relevant?

   

• Market value weights

• Book value weights

Answer 1

a

MV of equity=Price of equity*number of shares outstanding

MV of equity=5*10000000

=50000000

MV of Bond1=Par value*bonds outstanding*%age of par

MV of Bond1=1000*85000*1

=85000000

MV of Bond2=Par value*bonds outstanding*%age of par

MV of Bond2=1000*55000*1

=55000000

MV of firm = MV of Equity + MV of Bond1+ MV of Bond 2

=50000000+85000000+55000000

=190000000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 50000000/190000000

W(E)=0.2632

Weight of debt = MV of Bond/MV of firm

Weight of debt = 140000000/190000000

W(D)=0.7368

b

MV of equity=Price of equity*number of shares outstanding

MV of equity=82*10000000

=820000000

MV of Bond1=Par value*bonds outstanding*%age of par

MV of Bond1=1000*85000*0.97

=82450000

MV of Bond2=Par value*bonds outstanding*%age of par

MV of Bond2=1000*55000*1.05

=57750000

MV of firm = MV of Equity + MV of Bond1+ MV of Bond 2

=820000000+82450000+57750000

=960200000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 820000000/960200000

W(E)=0.854

Weight of debt = MV of Bond/MV of firm

Weight of debt = 140200000/960200000

W(D)=0.146

C

Market value capital structure