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Binomial Tree Farm’s financing includes $5.10 million of bank loans and $6.10 million book (face) value...

Binomial Tree Farm’s financing includes $5.10 million of bank loans and $6.10 million book (face) value of 10-year bonds, which are selling at 80% of par value. Its common equity is shown in Binomial’s Annual Report at $6.77. It has 510,000 shares of common stock outstanding which trade on the Wichita Stock Exchange at $15 per share. What debt ratio should Binomial use to calculate its WACC?

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Answer #1

- Market Value of Bank Loan = $5.10 million

- Market Value of Bond = Book Value*80% = $6.10 million*80% = $4.88 million

- Market Value of equity = No of shares outstanding*Price per share = 510,000*$15 = $7.65 million

Total Capital Structure = Market Value of Bank Loan + Market Value of Bond + Market Value of Equity

Total Capital Structure = $5.10 million + $4.88 million + $7.65 million

Total Capital Structure = $17.63 million

- Debt ratio to be used in WACC = Total Debt/Total Capital Structure

Total Debt =  Market Value of Bank Loan + Market Value of Bond = $9.98 million

Debt ratio to be used in WACC = $9.98 million/$17.63 million

Debt ratio to be used in WACC = 56.61%

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