Examine the following book-value balance sheet for University Products Inc. The

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 $16 per share and has a beta of 0.6. There are 3 million common shares outstanding. The market risk premium is 10%, the risk-free rate is 6%, and the firm’s tax rate is 40%. BOOK-VALUE BALANCE SHEET (Figures in $ millions) Assets Liabilities and Net Worth Cash and short-term securities $ 1.0 Bonds, coupon = 7%, paid annually (maturity = 10 years, current yield to maturity = 8%) $ 10.0 Accounts receivable 5.0 Preferred stock (par value $10 per share) 3.0 Inventories 9.0 Common stock (par value $0.10) 0.3 Plant and equipment 20.0 Additional paid-in stockholders’ equity 11.7 Retained earnings 10.0 Total $ 35.0 Total $ 35.0

a. 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.)

b. What is University’s WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Explanation / Answer

Market value of debt = PV(8%,10,-7%*10,-10) = 9.33

Equity value = 3*16 = 48

Preferred stock = (30/10)*3 = 9

Firm value = 9.33 + 48 + 9 = 66.33

Wd = 9.33 / 66.33 = 14.06%

We = 48 / 66.33 = 72.37%

Wp = 9 / 66.33 = 13.57%

Re = Rf + beta * risk premium

Re = 6% + 0.6 * 10% = 12%

Rp = 3/30 = 10%

Rd = 8%

WACC = Wd*Rd*(1-tax rate) + We*Re + Wp*Rp

WACC = 14.06%*8%*(1-40%) + 72.37%*12% + 13.57%*10% = 10.72%

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