As a consultant to GBH skiwear, you have been ask tocompute the appropriate disc

Question

As a consultant to GBH skiwear, you have been ask tocompute the appropriate discount rate to use to evalute thepurchase of a new warehouse facility. You have determined themarket value of the firm's capital structure as follows:

Source ofCaital            Market Value

Bonds                              $550,000

PreferredStock               $100,000

CommonStock               $420,000

To finance the pruchase, GBH will sell 20 year bonds with a $1,000 par value paying 7.5 percent per year (paid semiannually) , at the market price of $955. Preferred stock paying a $2.47 dividend can be sold for $34.68. Common stock for GBH is currently selling for $49.15 per share. The firm paid a $3.95 dividend last year and expects dividends to continue growing at a rate of 4.2 % per year into the indefinite future. The firm's marginal tax rate is 34 percent. What discount rate should you use to evaluate the warehouse project?

a) weight of debt?

b) weight of preferred stock?

c) weight of equity?

Explanation / Answer

a) weight of debt= Bond interest rate*(1-marginal tax rate)

                           =7.5%*(1-34%)= 4.95%

b)Weight of preferred stock= (Preferred stock dividend/ preferred stock price)*100

                                              = (2.47/34.68)*100=7.122%

c) weight of equity=(Dividend/common stock price)*100+growth rate

                               =(3.95/49.15)*100+4.2%=12.24%

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