Please HELP and show me how you worked the problem! Market Value Capital Structu
ID: 2649242 • Letter: P
Question
Please HELP and show me how you worked the problem!
Market Value Capital Structure value
Bonds, coupon=8% paid annually $20 million
($1000 par value, remaining maturity=10 years)
Preferred stocks $3 million
Common stocks $35 million
Total value $58 million
The bonds current price is $935.82. The preferred stocks are selling for $12 per share and the common stocks for $10 per share. The preferred stock pays $1 dividend per share. The common stocks beta is 1.2, the market risk premium is 8%, and the risk-free rate is 3%. The firms average tax rate is 40%.
a) Find the firms WACC.
b) Suppose that the firm is considering a project that is expected to generate $1 million per year for 5 years. If this project has the same risk as the firm has, how much is the firm willing to pay for this project?
Explanation / Answer
Cost of preferred stock =Dividend/Market price*100
=$1/$12
=8.33%
Cost of common stock using CAPM model:
Ke = Rf+Beta ( Rm-Rf)
Given Rf risk free rate=3%
Beta =1.2
Market risk premium =Rm-Rf =8%
Substituting the values in the formula:
Ke= 3%+1.2*8%
=3%+9.6%
=12.6%.
Cost of Debt:
Yield to maturity =[C+(F-P)/n]/(F+P)/2
Given C=Coupon = 8% of $1,000 =$80.
F=$1000 P=current market price =$935.82
N=10 is the period left to maturity.
Substituting the values in the above formula:
[80+($1,000-$935.82/10)]/[($1,000+935.82)/2]
=0.089283 *100
=8.928%
After tax cost of debt = (1-0.40)*8.928%
=5.356986% rounded to 5.36%
Weighted average cost of capital basing on the market value:
Answer for subpoint b:
As the project is having the same risk as that of the company's WACC, the cash flows must be discounted with the WACC to arrive at the present value of cash flows generated by the project.
Therefore, the firm must be willing to pay anything less than $3,793,887.74. In case payment is made more than this amount then NPV of the project would be negative and should be considered as not feasible
Particulars Book value Market value Weight Cost Weight* Cost Bonds $20,000,000.00 $18,716,400.00 0.326545282 5.36% 1.750% Preferred stock $3,000,000.00 $3,600,000.00 0.062809248 8.33% 0.523% Common stock $35,000,000.00 $35,000,000.00 0.61064547 12.60% 7.694% $57,316,400.00 1 9.968%