Question

A company has 10.1 million shares of common stock outstanding, 450,000 shares of 5 percent preferred stock outstanding, and 235,000 8.9 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $49 per share and has a beta of 1.55, the preferred stock currently sells for $99 per share, and the bonds have 15 years to maturity and sell for 116 percent of par. The market risk premium is 8.9 percent, T-bills are yielding 4 percent, and the company’s tax rate is 38 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 to the firm's typical project, what rate should the firm use to discount the project's cash flows?

Answer 1

total market value is $812.05 million

WACC project discount rate is 8.77%

Step-by-step explanation:

The firm's market value is the sum of the market values of equity,debt and preferred stock.

Equity=10.1*$49=$494.9 million

debt=235,000*$1000*116%=$272.6 million

preferred stock=450,000*$99=$44.55 million

Total market value $812.05 million

WACC=Ke*E/V+Kd*D/V*(1-t)+Kp*P/V

Ke is the cost of equity=4%+1.55(8.9%-4%)=11.60%

Kd= rate(30,$1000*8.9%/2,-$1000*116%,1000)=3.57% semiannually

kd=3.57%*2=7.14%

Kp=5%

WACC=(11.50%*494.9/812.05)+(7.14%*272.6/812.05*(1-0.38)+(5%*44.55/812.05)=8.77%