Examine the following book-value balance sheet for University Products, Inc. Wha

Question

Examine the following book-value balance sheet for University Products, Inc. What is the capital structure of the firm on the basis of market values? The perferred stock currently sells for $15 per share and the common stock for $20 per share. THere are 1 million common shares outstanding?

Assets

Cash and short term securites = $1

Accounts receivable= $3

Inventories= $7

Plant and equipment= $21

Total = $32

Liabilties and net worth

Bonds, coupon= 8%, paid annually (maturity =10 yrs, current YTM= 9%) = $10.0

Preferred stock (par value $20 per share) = $2.0 $

Common stock (par value $.10) = .1

Additional paid-in stockholders capital = 9.9

Retained earnings = 10.0

Total = $32.0

Show work. Thank you!

Explanation / Answer

First find debt's market value:

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

For references on the PV formula see:
http://www.netmba.com/finance/time-value/annuity/

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 common stock:

There are one million common shares outstanding. If the current market
value of each share of common stock is $20 we have that:

Market value of common stock = 1,000,000 shares * $20 =
= $20 million


The Capital Structure for University Products, Inc. based on market value is:

Market value of debt_________ $9.36 million -----> 30.33%
Market value of preferredstock__ $1.5 million -----> 4.86%
Market value of common stock__ $20.0 million -----> 64.81%
---------------------
Total market value of firm______ $30.86 million

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