Erna Corp. has 6 million shares of common stock outstanding. The current share p
ID: 2723263 • Letter: E
Question
Erna Corp. has 6 million shares of common stock outstanding. The current share price is $72, and the book value per share is $7. Erna Corp. also has two bond issues outstanding. The first bond issue has a face value of $70 million, has a coupon of 7 percent, and sells for 97 percent of par. The second issue has a face value of $50 million, has a coupon of 8 percent, and sells for 106 percent of par. The first issue matures in 22 years, the second in 6 years.
a. What are Erna’s capital structure weights on a book value basis? (Round your answer to 4 decimal places. (e.g., 32.1616))
Equity/Value
Debt/Value
b. What are Erna’s capital structure weights on a market value basis? (Round your answer to 4 decimal places. (e.g., 32.1616))
Equity/Value
Debt/Value
c. Which are more relevant, the book or market value weights?
Explanation / Answer
Solution:
a)
Weight at Book Value
Capital Structure
Book Value
Book Value Weight
Common Stock (6,000,000 x 7)
42000000
0.2593
Bond Value:
First Bond
$70,000,000
Second Bond
$50,000,000
Total Bond Value
$120,000,000
0.7407
Total Value of Capital
$162,000,000
1.0000
Equity/Value = 0.2593
Debt/Value = 0.7407
b)
Weight at Market Value
Capital Structure
Market Value
Market Value Weight
Common Stock (6,000,000 x 72)
$432,000,000
0.7813
Bond Value:
First Bond
$67,900,000
Second Bond
$53,000,000
Total Bond Value
$120,900,000
0.2187
Total Value of Capital
$552,900,000
1.0000
Equity/Value = 0.7813
Debt/Value = 0.2187
c)
Market Value shows the current situation of company’s strength and value. Hence more relevant is the market value weights.
Weight at Book Value
Capital Structure
Book Value
Book Value Weight
Common Stock (6,000,000 x 7)
42000000
0.2593
Bond Value:
First Bond
$70,000,000
Second Bond
$50,000,000
Total Bond Value
$120,000,000
0.7407
Total Value of Capital
$162,000,000
1.0000
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