Answer:
A. The Capital structure is : 4.23 % - Equity, 6.59 % - Preferred Shares and 89.17 % - Debt
B. The firm should discount the project’s cash flows at 4.45 %.
Explanation:
Total Market Value = Market Value of Equity + Market Value of Debt + Market Value of Preferred Shares
Market Value of Equity = 280,000 shares × $61
= $17,080,000
Market Value of Preferred Shares = 280,000 shares × $95
= $26,600,000
Market Value of Debt = 165,000 bonds × $2,000 × 109%
= $359,700,000
Total Market Value = $403,380,000
Capital Structure :
Weight of Equity = $17,080,000 / $403,380,000 × 100
= 4.23 %
Weight of Preferred Shares = $26,600,000 / $403,380,000 × 100
= 6.59 %
Weight of Debt = $359,700,000 / $403,380,000 × 100
= 89.17 %
Thus, the market value capital structure is : 4.23 % - Equity, 6.59 % - Preferred Shares and 89.17 % - Debt
<em>Firms use the Weighted Average Cost of Capital (WACC) to discount the project’s cash flows.</em>
<u>Cost of Debt,</u><u> r</u>
PV = $2000 × 109 % = - $2,100
PMT = ($2,000 × 5.9%) ÷ 2 = $59
n = 19 × 2 = 38
P/YR = 2
FV = $2,000
r = ?
Using a Financial Calculator, Pretax cost of debt, r is 5,47 %
After tax cost of debt = Interest × ( 1 - tax rate)
= 5,47 % × ( 1 - 0.25)
= 4.10 %
<u>Cost of Equity</u>
Cost of Equity = Return on Risk Free Security + Beta × Return on Risk Premium Portfolio
= 3.5 % + 1.15 × 7.1%
= 11.67 %
<u>Cost of Preference Stock </u>
Cost of Preference Stocks = 4.5%
<em />
WACC = ke(W/V) + kd(D/V) + kp(P/V)
= 11.67 % × 4.23 % + 4.10 % × 89.17 % + 4.5% × 6.59 %
= 4.45 %
