Question

Masterson, Inc., has 4.4 million shares of common stock outstanding. The current share price is $89.50, and the book value per share is $11.25. The company also has two bond issues outstanding. The first bond issue has a face value of $81 million, a coupon rate of 5.1%, and sells for 96.5% of par. The second issue has a face value of $53 million, a coupon rate of 5.8%, and sells for 106.5% of par. The first issue matures in 25 years, the second in 9 years. The most recent dividend was $4.28 and the dividend growth rate is 5.3%. Assume that the overall cost of debt is the weighted average of that implied by the two outstanding debt issues. Both bonds make semi-annual payments. The tax rate is 21%.
a. What are the company's capital structure weights on a book value basis?
b. What are the company's capital structure weights on a market value basis?
c. Which are more relevant, the book or market value weights?

Answer 1

Answer:

Masterson, Inc.

1. The company's capital structure weights on a book value basis are:

Book Value Weights:

Equity = 0.27 or 27%

Debts = 0.73 0r 73%

2. The company's capital structure weights on market value basis are:

Market Value Weights:

Equity = 0.75 or 75%

Debts = 0.25 or 25%

3. The market value weights of Masterson's common stock and debts are more relevant because they represent a more current valuation of the equity and the debts.  It is easier to calculate the book value weights since the information is more readily available within the entity than the information on market weights.

Explanation:

a) Data and Calculations:              

Equity                                     Units                     Total Value

Outstanding common stock  4.4 million shares

Current share price              $89.50                  $393.8 million

Book value per share           $11.25                    $49.5 million

Debt                                        Units                     Total Value

First bond:

 Face value                             81,000                   $81 million

 Market value                         81,000                    $78.165 million

Coupon rate =                         5.1%                       $4.131 million p.a.

Second bond:

 Face value                            53,000                   $53 million

 Market value                        53,000                   $54.445 million

Coupon rate =                        5.3%                      $2,809 million p.a.

Total book value of bonds    134,000                 $134 million

Total market value of bonds 134,000                 $132.61 million

Capital structure      Equity                    Bonds                 Total

Book value              $49.5 million          $134 million       $183.5 million

Market value           $393.8 million        $132.61 million  $526.41 million

Book Value Weights:

Equity = $49.5/$183.5 = 0.27 or 27%

Debts = $134/$183.5 = 0.73 0r 73%

Market Value Weights:

Equity = $393.8/$526.41 = 0.75 or 75%

Debts = $132.61/$526.41 = 0.25 or 25%