Part 1: Book Value Balance Sheet (all values in millions) ASSETS: Cash & Equival
ID: 2699552 • Letter: P
Question
Part 1: Book Value Balance Sheet (all values in millions)
ASSETS: Cash & Equivalents = $2, Accounts receivable = $3, Inventories = $7, Plant & equipment = $10, Total = $22
LIABILITIES AND NET WORTH: Bonds: coupon = 8%, $10.0 Paid annually (maturity = 10 years, current YTM (rd) = 9%), Preferred stock (par value 2.0 = $20 per share), Common stock (par value 0.1 = $0.10), Accounts payable = $9.9, Total = $22
Note the following market factors: The preferred stock currently sells for $15 per share and the common stock for $20 per share, and there are 1 million shares of common stock outstanding (= $100,000 / 0.1). Based on a market-value balance sheet, what is the current capital structure of the firm? (That is, what are the relative weights of debt, preferred stock, and common equity for Rawling, (wd, wps, and wce). Note that the total market value of the firm%u2019s equity would be the market price per share times the total number of shares outstanding (or MVEQUITY = Po x # of Shares)
Part 2: If Rawling's preferred stock pays a dividend of $2 per share, the beta of its common stock is 0.8, the market risk premium is 10 percent (i.e., RPm = (rmkt %u2013 rrf) = 10%), the risk-free rate (rrf) is 6 percent, and the firm%u2019s tax rate is 40 percent, what is Rawling%u2019s weighted average cost of capital (WACC)?
Explanation / Answer
Market value of debt = PV of future payments (coupons and principal)
discounted at cost of debt (the yield to maturity)
Coupon payments = 0.08 * $10 million = $0.8 million
PV of Coupons:
PV = C/(1+R) + C/(1+R)^2 + ... + C/(1+R)^10 =
= (C/R) * [(1 - (1 / (1 + R)^10))] =
= (0.8 / 0.09) * [(1 - (1 / (1.09)^10))] =
= 8.888 * 0.5776 =
= $5.134 million
PV of principal:
PV = P / (1 + R)^10 =
= $10 million / (1.09)^10 =
= $4.224 million
Market value of debt = PV of Coupons + PV of principal =
= $5.134 million + $4.224 million =
= $9.36 million
-Market value of preferred stock:
We have $2.0 million in preferred stocks at a par value of $20, this
means that we have (2.0 million / 20 =) 100,000 shares of preferred
stock.
If the current market value of each share of prefered stock is $15 we have that:
Market value of preferred stock = 100,000 shares * $15 =
= $1.5 million
-Market value of com