Organic Produce Corporation has 9.1 million shares of common stock outstanding,

Question

Organic Produce Corporation has 9.1 million shares of common stock outstanding, 660,000 shares of 7.1 percent preferred stock outstanding, and 191,000 of 8.3 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $65.60 per share and has a beta of 1.36, the preferred stock currently sells for $106.40 per share, and the bonds have 16 years to maturity and sell for 88 percent of par. The market risk premium is 6.85 percent, T-bills are yielding 5.55 percent, and the firm’s tax rate is 30 percent. Required: (a) What is the firm's market value capital structure? (Do not round intermediate calculations. Round your answers to 4 decimal places (e.g., 32.1616).) Market value weight of debt 0.2013 Market value weight of preferred stock 0.0838 Market value weight of equity 0.7149 (b) If the firm is evaluating a new investment project that has the same risk as the firm’s typical project, what rate should the firm use to discount the project’s cash flows? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Explanation / Answer

(a) What is the firm's market value capital structure?

We have to calculate market value of each type of financing as follows:

Market Value of company V =$835,264,000

Market Value Weight of each financing is as follows

(b) If the firm is evaluating a new investment project that has the same risk as the firm’s typical project,the firm should use WACC to discount the project’s cash flows.

To find WACC we have to find out cost of capital of each financing as follows:

Using CAPM model Cost of Equity is KE = Rf+ Beta(Rm-Rf)

= 5.55% +1.36(6.85%-5.55%) = 7.32%

The cost of Debt is YTM of Bonds So,

P0 =$880 =$ 41.5(PVIFA,R%,32)+$1000(PVIF,R%,32)

R = 4.9%

YTM = 4.9% *2 = 9.8%

After tax cost of Debt is = 9.8%(1-0.3) = 6.86%

Cost of Preference share = $7.1/$106.40 =6.67%

Now we can calculate WACC as follows

KWACC =WDKD+WPKP +WEKE

= (0.2012*0.0686)+(0.841*0.0667)+(0.7147*0.0732)

= 0.0717 OR 7.17%

$ MVD= 191,000 bonds* ($1000*.88) =191,000 bonds*$880 =     168,080,000 MVP= 660,000 shares *$106.40=       70,224,000 MVE= 9.1 million shares* $65.60 =     596,960,000 Total Market Value     835,264,000

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