Question

Use the following information to answer questions 18 through 25: Acme Services’ CFO is considering whether to take on a new project that has average risk. She has collected the following information: The company has outstanding bonds that mature in 26 years. The bonds have a face value of $1,000, an annual coupon of 7.5%, and sell in the market today for $920. There are 10,000 bonds outstanding. The risk-free rate is 6%. The market risk premium is 5%. The stock’s beta is 1.2. The company’s tax rate is 40%. The company has 50,000 shares of preferred stock with a par value of $100. These shares are currently trading at $105, and pay an annual dividend of $5.40. The company also has 1,850,000 common shares trading at $25. These shares last paid an annual dividend of $0.93. What is Acme’s wp? a) 2.73% b) 9.39% c) 13.49% d) 8.65% e) 7.03% What is Acme’s ws? a) 76.19% b) 84.88% c) 54.63% d) 15.55% e) 45.24%

Answer 1

MV of equity=Price of equity*number of shares outstanding

MV of equity=25*1850000

=46250000

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=1000*10000*0.92

=9200000

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=105*50000

=5250000

MV of firm = MV of Equity + MV of Bond+ MV of Preferred equity

=46250000+9200000+5250000

=60700000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 46250000/60700000

W(E)=0.7619 = 76.19%

Weight of preferred equity = MV of preferred equity/MV of firm

Weight of preferred equity = 5250000/60700000

W(PE)=0.0865 = 8.65%