Question

A firm’s debt has a par value of $1,000,000. The market value of this debt is...

A firm’s debt has a par value of $1,000,000. The market value of this debt is $1,100,000. The coupon rate is 7% and the debt has 8 years left to maturity. Interest is paid annually. The tax rate is 40%. There are 100,000 shares of stock outstanding with a par value of $20 per share. The per share stock price is $25. What should be the approximate debt ratio for this firm?

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Answer #1

Debt:

Market Value of Debt = $1,100,000

Equity:

Number of shares outstanding = 100,000
Current Price per share = $25

Market Value of Equity = Number of shares outstanding * Current Price per share
Market Value of Equity = 100,000 * $25
Market Value of Equity = $2,500,000

Market Value of Firm = Market Value of Debt + Market Value of Equity
Market Value of Firm = $1,100,000 + $2,500,000
Market Value of Firm = $3,600,000

Debt Ratio = Market Value of Debt / Market Value of Firm
Debt Ratio = $1,100,000 / $3,600,000
Debt Ratio = 30.56%

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