I don\'t know how to convert the Book value to the market value or to find the w

Question

I don't know how to convert the Book value to the market value or to find the weight or the weight cost.

        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 bond

Explanation / Answer

Market Value of Bond = number of bonds xcurrent market price = ($20 million / $1000) x 935.82 = $18716400

Market value of the Prefrence stock = number of Preference stocks xcurrent market price

= ($3000000/$10) x $12 = $3600000

Market Value of Common stock = $35000000

Cost of Preference Stock = (dividend / Market value) = $1 / $12 = 8.33 %

Cost of Common Stock

= risk free rate + beta x (Market Risk premium) [Applying CAPM]

= 3% + 1.2 x 8%

= 12.6%

Before tax cost of Bond:

Let R be the yield to maturity.

By the problem,

935.82 = Coupon Interest x PVIFA (R%, 10years) +Maturity Value x PVIF (R%, 10)

By trial and error method we get,

R Market Value

9% 80 x 6.418 + 1000 x 0.422 = $ 935.44

YTM = $ 935.82

8% 80 x 6.71 + 1000 x 0.463 = $ 999.80

Using interpolation we get,

YTM = 9% + [(935.82 - 935.44) / (999.80 - 935.44)] x (8% - 9%) = 9% - 0.006% = 8.994%

Therefore Before Tax Cost of Bond = 8.994%

After Tax Cost of Bond = 8.994 x 0.60 = 5.4%

WACC = 9.98%

Note: Weight of bond = $18716400 / $ 57316400 = 0.326545 (the other have been calculated similarly)

Weighted Cost of Bond = weight x cost = 0.326545 x 5.4% = 0.17633445 (the other have been calculated similarly)

Part 2)

Since the project is in the same risk class, the cost of capital to be used for the project is 9.98%

The project will generate $1 million per year for 5 years.

The present value of annuity of $1 million discounted at 9.98%

= $1 000000 x PVIFA (9.98%, 5years)

= 1000000 x 3.793 = $3.793 million

So the firm will be willing to pay for the project an amount less than $3.793 million to generate positive NPV.

Source of Capital Book Value Market Value Cost Weight Weighted Cost Bond 20000000 18716400 0.054 0.326545 0.017633445 Preference Stock 3000000 3600000 0.083 0.062809 0.00523201 Common Stock 35000000 35000000 0.126 0.610645 0.076941329 57316400 1 0.099806785

Related Questions

Navigate

• Browse (All)
• Browse I
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.