Question

Use the following information to answers questions 17 to 26.  (Long Answer/Essay – primarily Chapter 13 but includes concepts from many chapters) You are the CFO of Micro Spinoff Inc. The company has 3,000,000 shares of common stock outstanding at a market price of $50 a share. Micro Spinoff just paid an annual dividend in the amount of $3.12 per share. The dividend growth rate is 5.8 percent annually. Micro Spinoff also has 70,000 bonds outstanding with a face value of $1,000 per bond that are selling at 115.372 percent of par. The bonds have a 12 percent coupon, pay interest semi-annually, and have 15 years to maturity. Finally, the firm has 400,000 shares of preferred stock outstanding at a market price of $58.48 a share. Preferred stocks pay dividend of 6.67 percent on its par value of $75.00.

20. The firm is considering a three-year expansion project (same operations as the existing projects of the firm) that requires an initial investment in a machine of $200,000. The increase in Net Working Capital (NWC) at time 0 is $10,000 that will be reduced to normal levels at the end of the project at time 3. The machine has a life of 4 years and will be depreciated to 0 using straight-line method. The Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) in the first year is $70,000 and this will grow at 6 percent a year. At the end of the project (year 3), the machine can be sold for $10,000. The firm’s tax rate is 21 percent.

1. calculate the weigts of equity, debt, and preferred stock

Answer 1

In order to compute the weight of each asset class, we need to compute its market value and compute the company enterprise value. Based on that, we will be able to compute the individual weights of each asset class in its overall cost of capital.

Valeu of Equity = Share price x Shares outstanding = 3,000,000 x 50 = $150,000,000
Value of Preferred Stock = Share price x Shares outstanding = 400,000 x 58.48 = $23,392,000
Value of Debt = price at which it is selling to par times shares outstanding
= 1153.72 X 70000
   = $80,760,400

Total value of the firm (Enterprise Value) = Value of Equity + Value of Preferred Stock + Value of Debt
           = $150,000,000 + $23,392,000 + $80,760,400
           = $254,152,400

Therefore, the weight of equity, for example, equals its market value divided by the total enterprise value of the company.

Equity Weight = Equity Value / Debt +Equity + Pref Stock
= $150,000,000 / $ 254,152,400
= 59%
Debt Weight = Debt Value / Debt +Equity + Pref Stock
=$80,760,400/ $ 254,152,400
= 32%

Preference Weight = Preference Value / Debt +Equity + Pref Stock
= $23,392,000 / $ 254,152,400
= 9%

Particulars Total market Value   Weights (In %)
Debt $80,760,400   32%
Prefrence Stock $23,392,000   9%
Equity $150,000,000   59%
Enterprise Value $254,152,400