4:18 PM ezto.mheducation.com 00 Sprint 85% 20.00 points Problem 13-13 WACC (LO3)

Question

4:18 PM ezto.mheducation.com 00 Sprint 85% 20.00 points Problem 13-13 WACC (LO3) Examine the following book-value balance sheet for University Products Inc. The preferred stock currently sells for $30 per share and pays a dividend of $3 a share. The common stock sells for $16 per share and has a beta of.6. There are 3 million common shares outstanding. The market risk premium is 8%, the risk-free rate is 4%, and the firm's tax rate is 40%. BOOK-VALUE BALANCE SHEET (Figures in $ millions) Assets Cash and short-term securities Accounts receivable Inventories Plant and equipment $ 1.0 3.0 7.0 25.0 Liabilities and Net Worth Bonds, coupons 8%, paid annually (maturity- 10 years, current yield to maturity = 9%) Preferred stock (par value $10 per share) Common stock (par value $.10) Additional paid-in stockholders' equity Retained earnings $5.0 3.0 16.7 11.0 Total $36.0 Total $36.0 a. What is the market debt-to-value ratio of the firm? (Do not round intermediate calculations. Enter vour answer as a percent rounded to 2 decimal places.) Market debt ratio What is University's WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) WACC References Worksheet Difficulty: Intermediate Problem 13-13 WACC (LO3) Learning Objective: 13-03 Calculate the weighted average cost of capital

Explanation / Answer

a. Market debt-to-value ratio = Total Liabilities / (Total Liabilities + Market value of equity)

= $5 million / ($5 million + $16 * 3 million)

= 9.43%

b. Cost of debt = YTM = 9%

Cost of preferred stock = $3 / $30

= 10%

Cost of equity = 4% + 0.6 * 8%

= 8.8%

WACC = [Cost of debt * (1 - tax rate) * Value of debt + Cost of preferred stock * Value of preferred stock + Cost of equity * Value of equity] / [Value of debt + Value of preferred stock + Value of equity]

= [9% * (1 - 40%) * $5 million + 10% * 0.3 million * $30 + 8.8% * 3 million * $16] / [$5 million + 0.3 million * $30 + 3 million * $16]

= 8.7%

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