Examine the following book-value balance sheet for University Products Inc. The
ID: 2759533 • Letter: E
Question
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 $10 per share and has a beta of .9. There are 4 million common shares outstanding. The market risk premium is 8%, the risk-free rate is 4%, and the firm’s tax rate is 40%.
What is the market debt-to-value ratio of the firm? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
What is University’s WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
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 $10 per share and has a beta of .9. There are 4 million common shares outstanding. The market risk premium is 8%, the risk-free rate is 4%, and the firm’s tax rate is 40%.
Explanation / Answer
Answer
Answer a
Market debt ratio = Total liabilities / Total liabilities + market value of equity
= $ 20 million / $ 20 million + (4 million * 10)
= $ 20 million / $ 20 million + (40 million)
= $ 20 million / $ 60 million
= 0.3333
So Market debt ratio = 33.33%
Answer b
Market value of bonds = Interest / Current yield to maturity
= 20 million * 0.05 / 0.07
= 1 million / 0.07
= 14.28571429 million
Market value of preferred stock = Market value per share * No. of preferred stock
= $ 30 * ( $ 3000000/20)
= $ 30 * 150000
= 4.5 million
Market value of Equity stock = No. of shares * current market price
= (4 million * 10)
= 40 million
Cost of Debt after tax = 5% (1 – 0.4)
= 5% (0.6)
=3%
Cost of preferred stock = Dividend / Current market price
= $3 / $ 30
Cost of preferred stock = 10%
Cost of equity = Risk free rate + beta (market risk premium)
= 4% + 0.9 (8%)
= 4% + 7.2%
= 11.2%
Particulars
Market value
Weight
Cost of capital
Weighted Average Cost of Capital
in million
A
B
A*B
Bond
14.29
0.24
3%
0.73%
Preferred stock
4.5
0.08
10%
0.77%
Equity
40
0.68
11.20%
7.62%
58.79
1.00
Weighted average cost of capital
9.12%
Particulars
Market value
Weight
Cost of capital
Weighted Average Cost of Capital
in million
A
B
A*B
Bond
14.29
0.24
3%
0.73%
Preferred stock
4.5
0.08
10%
0.77%
Equity
40
0.68
11.20%
7.62%
58.79
1.00
Weighted average cost of capital
9.12%
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.