Erna Corp. has 9 million shares of common stock outstanding. The current share p
ID: 2723643 • Letter: E
Question
Erna Corp. has 9 million shares of common stock outstanding. The current share price is $75, and the book value per share is $6. Erna Corp. also has two bond issues outstanding. The first bond issue has a face value of $85 million, has a coupon of 10 percent, and sells for 96 percent of par. The second issue has a face value of $65 million, has a coupon of 11 percent, and sells for 109 percent of par. The first issue matures in 25 years, the second in 9 years.
What are Erna’s capital structure weights on a book value basis? (Round your answer to 6 decimal places. (e.g., 32.1616))
What are Erna’s capital structure weights on a market value basis? (Round your answer to 6 decimal places. (e.g., 32.1616))
Which are more relevant, the book or market value weights?
Erna Corp. has 9 million shares of common stock outstanding. The current share price is $75, and the book value per share is $6. Erna Corp. also has two bond issues outstanding. The first bond issue has a face value of $85 million, has a coupon of 10 percent, and sells for 96 percent of par. The second issue has a face value of $65 million, has a coupon of 11 percent, and sells for 109 percent of par. The first issue matures in 25 years, the second in 9 years.
Explanation / Answer
a.
Erna’s capital structure weights on a book value basis:
Note: it is assumed that bonds are issued now and discount and premiums are not amortised till now.
b.
Erna’s capital structure weights on a market value basis:
c. Market value weight is more relevant than book value.
Reason: The book value weights are readily available from balance sheet for all types of firms and are very simple to calculate. On the other hand, for Market Value weights, the market values have to be determined and it is a real difficult task to acquire accurate data for the same especially the value of equity when the entity is not listed. Still Market Value WACC is considered appropriate by analysts because an investor would demand market required rate of return on the market value of the capital and not the book value of the capital.
(Discount)/Premium Book Value Book Value, $ Mn Weightage Remarks Equity 54 26.1565 9mn * $6 Debt 10% Coupon 85 3.4 81.6 Discount of 4% is deducted from face Value 11% Coupon 65 5.85 70.85 152.45 73.8435 Primium of 9% is added to face Value Total 206.45 100.000000Related Questions
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