Question

# Forrest Corporation has 500,000 shares of common stock, 10,000 shares of preferred stock, and 5,000 bonds...

Forrest Corporation has 500,000 shares of common stock, 10,000 shares of preferred stock, and 5,000 bonds with 8 percent (coupon) outstanding. The common stock currently sells for \$25 per share and has a beta of 0.95. Preferred stocks pay a dividend of \$8 per share and currently sell for \$98 with a floatation cost of \$2 per share. The bonds have par value of \$1,000, 20 years to maturity, currently sell for 102.5 percent of par, and the coupons are paid semiannually. The bond’s floatation cost is 1% of the current market price. The expected return on market portfolio is 9 percent, T-bills are yielding 2 percent, and the tax rate is 35 percent. What is the firm’s market value capital structure? If Forrest is evaluating a new investment project that has the same risk as the firm’s typical project, what rate should the firm use to discount the project’s cash flows?

Market Value of debt = \$1025 x 5000 bonds = \$5,125,000

Market Value of Common Stocks = \$25 x 500,000 shares = \$12,500,000

Market Value of Preferred Srocks = \$98 x 10,000 shares = \$980,000

Total Capital Emplyed = \$5,125,000 + \$12,500,000 + \$980,000 = \$18,605,000

Debt % in total capital = \$5,125,000 \$18,605,000 = 27.55%

Common equity % in total capital = \$12,500,000 \$18,605,000 = 67.18%

Preferred Stock % in total capital = \$980,000 \$18,605,000 = 5.27%

If Forrest is evaluating a new investment project that has the same risk as the firm’s typical project, then the firm should use Weighted Average Cost of Capital (WACC) to discount the project’s cash flows.