Question

Hankins Corporation has 7.5 million shares of common stock outstanding, 275,000 shares of 4.7 percent preferred stock outstanding, par value of $100; and 160,000 bonds with a semiannual coupon rate of 5.6 percent outstanding, par value $2,000 each. The common stock currently sells for $62 per share and has a beta of 1.10, the preferred stock has a par value of $100 and currently sells for $94 per share, and the bonds have 18 years to maturity and sell for 108 percent of par. The market risk premium is 7.2 percent, T-bills are yielding 3.4 percent, and the company’s tax rate is 24 percent.
What is the firm's market value captial structure?

Answer 1

Answer:

7.98%

Explanation:

For computing the market value capital structure we need to do following calculations which are shown below:

Market value of stock = 7,500,000 ×  $62 per share = $465,000,000

Cost of Equity = Risk Free rate + Beta × Market risk Premium

= 3.4% + 1.10 × 7.2%

= 11.32%

Market value of Bond = 108% × $2,000 × 160,000 bonds = $345,600,000

Coupon = 5.6% × 2000 ÷ 2 = 56

Number of Periods(n) = 18 × 2 = 36

Market value = $2000 × 1.08 = $2160

Cost of debt (YTM) using excel formula is

= RATE(36,56,$2,000,-$2,160)

= 4.92%

Market value of Preferred Stock = 275,000 × $94 = $25,850,000

Cost of Preferred Stock = 4.7%

Total value = $465,000,000 + $345,600,000 + $25,850,000

= $836,450,000

Equity ratio = $465,000,000 ÷  $836,450,000 = 0.5559

Debt ratio = $345,600,000 ÷ $836,450,000 = 0.4132

Preferred Stock ratio = $25,850,000 ÷ $836,450,000 = 0.0309

Now the market capital structure is

Cost of Project = Equity Ratio × Cost of Equity + Debt ratio × ( 1-Tax rate) × Cost of Debt + Preferred Stock ratio × Cost of Preferred stock

= 0.5559 × 11.32% + 0.4132 × (1 -24%) × 4.92% +  0.0309 × 4.7%

= 7.98%