Question

# A company has 2 million shares outstanding that are currently priced at \$4 each and have...

A company has 2 million shares outstanding that are currently priced at \$4 each and have a beta of 1.3. Five years ago the company issued bonds with a total face value of \$3 million. One bond has a face value of \$250,000. The bonds have a coupon rate of 3% p.a. and coupons are paid every six months. The bonds mature in fifteen years from today. The bonds currently yield 4% p.a., the market return is 7% p.a., the risk-free return is 2% p.a., and the company tax rate is 30%.

What proportion of the firm's capital structure is equity?

Market value of equity = number of shares × price

= 2,000,000 × 4

= \$8,000,000

Total debt= \$3,000,000

Face value = \$250,000

Number of bonds = total debt / face value

= 3,000,000 / 250,000

= 12

Current yield = Annual coupon / current market price

Current market price= Annual coupon / Current yield

= 250,000 × 3% / 0.04

= 7,500 / 0.04

= \$187,500

Total market value of debt= 187,500 × 12

= \$2,250,000

Total market value of firm = market value of equity + market value of debt

= 8,000,000 + 2,250,000

= \$10,250,000

Proportion of equity= Market value of equity / Total market value of firm

= 8,000,000 / 10,250,000

= 0.7805 or 78.05%