Question

Your firm has 500,000 shares of common stock outstanding and 100,000 bonds outstanding.

The firm has a required rate of return of 14%, the next annual dividend is SS and dividends are expected to grow at 8%. The bonds mature in 15 years, pay annual coupons with a 5% coupon rate, have a face value of $1000, and a yield to maturity of 7%.

a) Compute the price per share based on the dividend model

b) Compute the bond price

c) Compute the market value of equity

d) Compute the market value of long-term debt (E)Compute the weights of debt and equity based on market value

Answer 1

a). P0 = D1 / [r - g] = $5 / [0.14 - 0.08] = $5 / 0.06 = $83.33

b). To find the current bond price, we need to put the following values in the financial calculator:

INPUT	15	7		5%*1,000=50	1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT			-817.84

So, Bond price = $817.84

c). Market Value of equity = Share Price x No. of shares outstanding

= $83.33 x 500,000 = $41,666,666.67

d). Market Value of LTD = Bond Price x No. of bonds outstanding

= $817.84 x 100,000 = $81,784,171.99

e). Total Market Value = Market Value of equity + Market Value of LTD

= $41,666,666.67 + $81,784,171.99 = $123,450,838.70

wD = Market Value of LTD / Total Market Value

= $81,784,171.99 / $123,450,838.70 = 0.6625, or 66.25%

wE = Market Value of equity / Total Market Value

= $41,666,666.67 / $123,450,838.70 = 0.3375, or 33.75%