Case Narrative: A firm’s capital structure includes the following securities. It
ID: 2781328 • Letter: C
Question
Case Narrative:
A firm’s capital structure includes the following securities. It has 500,000 shares of common stock (equity) outstanding, selling for $20 per share. The preferred stock share price is $50, pays a $4 dividend with no growth expected. Each share of common stock sells for $20 and pays a $1.00 dividend, which is expected to grow by 2% per year. The current price of the bonds is $818, and the coupon rate is 5%. The bonds will mature in 10 years.
What is the market capitalization of the firm’s equity? ____________________________________________________ Chapter 4
What is the major factor that causes the market capitalization of a firm to increase or decrease? _____________________________________________Chapter 4
What is the cost (required rate of return) of the preferred stock? ______________________________________________________ Chapter 7
What is the cost (required rate of return) of the common stock? _______________________________________________________Chapter 7
What is the cost (yield to maturity %) of the bonds? _______________________________________________________Chapter 6
What caused the value of this bond to drop from $1,000 to $818? _______________________________________________________Chapter 6
Explanation / Answer
1. market cap of equity = 500,000*20 = 10,000,000
2. The change in price causes the market cap to increase or decrease
3. cost of preferred stock = 4/50 = 8.00%
4. cost of common stock = 1*1.02/20 + 2% = 7.10%
5. N = 10, FV = 1000, PMT = 50, PV = -818
use rate function in Excel
cost of debt = 7.67%
6. An increase in the yield to maturity causes the price of bond to fall
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