Question

WACC. Look at the following book-value balance sheet for University Products Inc. The preferred stock currently sells for $15 per share and pays a dividend of $2 a share. The coomon stock sells for $20 per share and has a beta of .8. There are 1 million common shares outstanding. The market risk premium is 10%, the risk free rate is 6% and the firm's tax rate is 40%

Assets         (all numbers are in the millions)                        

Cash& short -term securities $1 M                                                                                                                       Accounts Receivable            $3 M                                                                                                     

Inventories                          $7m                                       

Plant and Equipment             $21M      

Total Assets $32

Liabilities and Net Worth                                                                                                   

Bonds, coupon=8%, paid annually(maturity =10 years, current yield to maturity=9%)     $10M

Preferred stock (par value $20 per share)                                                                 $2M

Common Stock (Par Value $.10)                                                                              $0.1M

Additional paid n stockholders equity                                                                        $9.9M

Retained Earning                                                                                                   $10M

Total Liabilities and Net Worth                                                                                 $32M

                                                                                                                                                                                      

                                                                                                                                                              

A) What is the market debt to value ratio of the firm?

B) What is University's WACC?

Answer 1

Market value of common stock = 20*1million = $20 million

Market value of preferred stock = 15*($2M/$20) = $1.5 million

We need to find the market value of debt:

FV = $10 million

PMT = 8%*10 = 0.8 million

Rate per period = 9%

Number of periods = 10

Using PV function excel:

Value =-PV(9%,10,0.8,10) = $9.36 million

Total market value = 9.36 + 1.5 + 20 = $30.86 million

Market debt to value = 9.36/30.86 = 0.3033

b) Cost of preferred stock = D/P = 2/15 = 13.33%

Cost of common equity = risk free rate + beta*market risk premium = 6% + 0.8*10% = 14%

Cost of debt = 9%

WACC = W_d*K_d*(1-t) + W_p*K_p + W_e*K_e = (9.36/30.86)*9%*(1-0.4)+(1.5/30.86)*13.33% + (20/30.86)*14% = 11.36%