Again referring to Willerton of the two previous problems, assume the firm’s cost of retained earnings is 11% and its marginal tax rate is 40%, calculate its WACC using its book value based capital structure ignoring floatation costs.
Make the same calculation using the market value based capital structure. How significant is the difference?
6. A relatively young firm has capital components valued at book and market and market component costs as follows. No new securities have been issued since the firm was originally capitalized.
Component Market Book Cost
Debt $42,830 $40,000 8.5%
Preferred Stock $10,650 $10,000 10.6%
Common Equity $65,740 $32,000 25.3%
a. Calculate the firm’s capital structures and WACCs based on both book and market values, and compare the two.
b. What appears to have happened to interest rates since the company was started?
c. Does the firm seem to be successful? Why?
d. What would be the implication of using a WACC based on book as opposed to market values? In other words, what kinds of mistakes might management make by using the book values?
7. Five years ago Hemingway Inc. issued 6,000 thirty-year bonds with par values of $1,000 at a coupon rate of 8%. The bonds are now selling to yield 5%. The company also has 15,000 shares of preferred stock outstanding that pay a dividend of $6.50 per share. These are currently selling to yield 10%. Its common stock is selling at $21, and 200,000 shares are outstanding. Calculate Hemingway’s market value based capital structure.
8. The Wall Company has 142,500 shares of common stock outstanding that are currently selling at $28.63. It has 4,530 bonds outstanding that won’t mature for 20 years. They were issued at a par value of $1,000 paying a coupon rate of 6%. Comparable bonds now yield 9%. Wall’s $100 par value preferred stock was issued at 8% and is now yielding 11%; 7,500 shares are outstanding. Develop Wall’s market value based capital structure.
9. The market price of Albertson Ltd.’s common stock is $5.50, and 100,000 shares are outstanding. The firm’s books show common equity accounts totaling $400,000. There are 5,000 preferred shares outstanding that originally sold for their par value of $50, pay an annual dividend of $3, and are currently selling to yield an 8% return. Also, 200 bonds outstanding that were issued five years ago at their $1,000 face values for 30-year terms pay a coupon rate of 7%, and are currently selling to yield 10%. Develop Albertson’s capital structure based on both book and market values.