Question

Hero Manufacturing has 6 million shares of common stock outstanding. The current share price is $72 and the book value per share is $7. The company also has two bond issues outstanding, both with semiannual coupons. The first bond issue has a face value $70 million and a coupon of 7 percent and sells for 97 percent of par. The second issue has a face value of $50 million and a coupon of 8 percent and sells for 106 percent of par. The first issue matures in 22 years, the second in 6 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.)

Answer 1

Answer a.

Debt:

1^st Issue of Bonds:

Book Value = $70,000,000

2^nd Issue of Bonds:

Book Value = $50,000,000

Book Value of Debt = Book Value of 1^st Issue of Bonds + Book Value of 2^nd Issue of Bonds
Book Value of Debt = $70,000,000 + $50,000,000
Book Value of Debt = $120,000,000

Equity:

Number of shares outstanding = 6,000,000
Book value per share = $7

Book Value of Equity = Number of shares outstanding * Book value per share
Book Value of Equity = 6,000,000 * $7
Book Value of Equity = $42,000,000

Book Value of Firm = Book Value of Debt + Book Value of Equity
Book Value of Firm = $120,000,000 + $42,000,000
Book Value of Firm = $162,000,000

Weight of Debt = Book Value of Debt / Book Value of Firm
Weight of Debt = $120,000,000 / $162,000,000
Weight of Debt = 0.7407

Weight of Equity = Book Value of Equity / Book Value of Firm
Weight of Equity = $42,000,000 / $162,000,000
Weight of Equity = 0.2593

Answer b.

Debt:

1^st Issue of Bonds:

Book Value = $70,000,000

Market Value = 97% * $70,000,000
Market Value = $67,900,000

2^nd Issue of Bonds:

Book Value = $50,000,000

Market Value = 106% * $50,000,000
Market Value = $53,000,000

Market Value of Debt = Market Value of 1^st Issue of Bonds + Market Value of 2^nd Issue of Bonds
Market Value of Debt = $67,900,000 + $53,000,000
Market Value of Debt = $120,900,000

Equity:

Number of shares outstanding = 6,000,000
Market value per share = $72

Market Value of Equity = Number of shares outstanding * Market value per share
Market Value of Equity = 6,000,000 * $72
Market Value of Equity = $432,000,000

Market Value of Firm = Market Value of Debt + Market Value of Equity
Market Value of Firm = $120,900,000 + $432,000,000
Market Value of Firm = $552,900,000

Weight of Debt = Market Value of Debt / Market Value of Firm
Weight of Debt = $120,900,000 / $552,900,000
Weight of Debt = 0.2187

Weight of Equity = Market Value of Equity / Market Value of Firm
Weight of Equity = $432,000,000 / $552,900,000
Weight of Equity = 0.7813