The table shows the year end book value balance sheet for the company A. ($Milli
ID: 2645345 • Letter: T
Question
The table shows the year end book value balance sheet for the company A. ($Millions)
Assets
Liabilities and Equity
Cash
$1
Bonds
$10
A/R
3
Preferred Stock
2
Inventories
7
Common stock
10
Plant and Equipment
21
R/E
10
Total
$32
Total
$32
The bond has a face value of $1000, whose coupon rate is 8%. Coupon are paid annually, and the bond will mature in 10 years. The current yield to maturity is 9%. The preferred stock has a par value of $20 per share. The beta of the common stock is 1.5; the market risk premium is 7%
Assets
Liabilities and Equity
Cash
$1
Bonds
$10
A/R
3
Preferred Stock
2
Inventories
7
Common stock
10
Plant and Equipment
21
R/E
10
Total
$32
Total
$32
Explanation / Answer
Answer:
(1) Market value of the co. = Common Stock *Market value = 1 Million shares *$20 = $20 Million
(2) WACC =Cost of Debt * Weight of Debt + Cost of Pref. Stock * Weight of Pref. Stock+ Cost of equity * Weight of equity
Cost of Debt = YTM =9%
Cost of Pref. Stock = (Assumed 10% as it cannot be calculated with the info given)
Cost of Equity = Risk free rate + Beta *marker risk premium
=4% + 1.5*7% = 14.50%
Calculation of weight taking Market value of each component:
Market value of Debt = $10 Million
Market value of Pref. Stock = $2*$15/$20 = $1.5 Million
Market value of Equity = $20 Million
Total value = 10+1.5+20 = 31.50
Weight of Debt = 10/31.50 = 0.3175
Weight of Pref. Stock = 1.5/31.50 = 0.0476
Weight of Debt = 20/31.50 = 0.6349
Hence WACC = 9%*0.3175 +10%*0.0476 +14.5%*0.6349 = 0.1254 = 12.54%
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