Question

SHED-A-LOT, Inc. has two million shares of common stock outstanding selling at $27 per share. They also have one million shares of preferred stock outstanding and 10,000 bonds. Preferred shares are selling for $14.50 per share and the bonds are selling at 98. Calculate the weight you should use for the equity in the computation of SHED-A-LOT’s WACC.

Answer 1

The total market value of SHED-A-LOT's equity is calculated as $68.5 million ($54 million in common stock and $14.5 million in preferred stock). However, without knowing the firm’s total value including debt, we cannot compute the exact weight of equity in the WACC.

Step-by-step explanation:

To calculate the weight you should use for the equity in the computation of SHED-A-LOT's Weighted Average Cost of Capital (WACC), you first need to determine the total market value of the equity. This is done by the combination of the common and preferred stock market values. The total market value of common stock is calculated as 2 million shares multiplied by $27 per share, which equals $54 million. The total market value of preferred stock is calculated as 1 million shares multiplied by $14.50 per share, which equals $14.5 million. The sum of these two gives us the total market value of equity, which amounts to $68.5 million.

Now, to calculate the overall firm value, you would add the market value of the debt to the total market value of equity. However, as the question only asks for the weight of the equity, we focus on the $68.5 million equity value. The weight of equity in WACC is the proportion of the total firm value. Since we are not given the firm’s total value including debt, we cannot calculate the precise weight without making assumptions about the debt's market value, which we shall avoid in this case.