Question

Testbank, Question 15 An analyst has obtained the following information about Maudite Brewers Co.: Book value of assets $25,000; book value of common equity $10,000; book value of preferred shares $5,000. The company has 4,000 common shares outstanding which are currently trading at $5 per share. The company has 3,000 preferred shares outstanding which are currently trading at $2 per share. The yield on the debt equals the coupon rate. The weights used to determine the weighted average cost of capital are: Common Equity Preferred Equity Debt 55.56% 16.67% 27.77% 40% 20% 40% 80% 10% 10% Cannot be determined because we need the market value of debt.

Answer 1

Market Value Capital Structure

Market Value of Common Stock = $20,000 [4,000 Shares x $5 per share]

Market Value of Preferred Stock = $6,000 [3,000 Shares x $2 per share]

Market Value of Debt = $10,000 [Since, the yield on the debt equals the coupon rate, therefore, the Market Value of the Debt will be equals to the Book Value of the Debt. ($25,000 – $10,000 - $5,000)]

Total Market Value = $36,000 [$20,000 + $6,000 + $10,000]

Weights used to determine the weighted average cost of capital

Weight for Common Stock = [Market Value of Common Stock / Total Market Value] x 100

= [$20,000 / $36,000] x 100

= 55.56%

Weight for Preferred Stock = [Market Value of Preferred Stock / Total Market Value] x 100

= [$6,000 / $36,000] x 100

= 16.67%

Weight for Debt = [Market Value of Debt / Total Market Value] x 100

= [$10,000 / $36,000] x 100

= 27.77%

“Therefore, the Weights used to determine the weighted average cost of capital is Common Equity = 55.56%, Preferred Shares = 16.67%, Debt = 27.77%”