Question

Finding the WACC [뇨 LO3] Lingenburger Cheese Corporation has 6.4 million shares of common stock outstanding, 200,000 shares of 3.8 percent preferred stock outstanding, par value of $100, and 120,000 bonds with a semiannual coupon of 4.8 percent outstanding, par value $1,000 each. The common stock currently sells for $54 per share and has a beta of 1.08, the preferred stock currently sells for $103 per share, and the bonds have 15 years to maturity and sell for 107 percent of par. The market risk premium is 7.5 percent, T-bills are yielding 2.4 percent, and the company's tax rate is 22 percent. a. What is the firm's market value capital structure? b. If the company is evaluating a new investment project that has the same risk as the firm's typical project, what rate should the firm use to discount the project's cash flows? Input Area: Output Area: b. For projects equally as risky as the firm itself, the WACC should be used as the discount rate.

Answer 1

The firm's market value capital structure is $494.6 million. The rate that the firm should use to discount the cash flows of a new investment project.

Step-by-step explanation:

a. To determine the firm's market value capital structure, we need to calculate the market value of each component. The market value of common stock is 6.4 million shares multiplied by $54 per share, which equals $345.6 million. The market value of preferred stock is 200,000 shares multiplied by $103 per share, which equals $20.6 million. Adding these values together, the firm's market value capital structure is $494.6 million.

b. The rate that the firm should use to discount the cash flows of a new investment project with the same risk as the firm's typical projects is the weighted average cost of capital (WACC). The WACC is calculated by multiplying the cost of each component by its weight in the capital structure and summing them. The cost of common stock is the risk-free rate (T-bill yield) plus the beta multiplied by the market risk premium.