Question

Examine the following book-value balance sheet for University Products Inc. The preferred stock currently sells for $15 per share and pays a dividend of $3 a share. The common stock sells for $20 per share and has a beta of 0.7. There are 2 million common shares outstanding. The market risk premium is 12%, the risk-free rate is 8%, and the firm’s tax rate is 21%.

BOOK-VALUE BALANCE SHEET
(Figures in $ millions)
Assets					Liabilities and Net Worth
Cash and short-term securities	$	1.0			Bonds, coupon = 6%, paid annually (maturity = 10 years, current yield to maturity = 8%)	$	15.0
Accounts receivable		4.0			Preferred stock (par value $20 per share)		3.0
Inventories		8.0			Common stock (par value $0.10)		0.2
Plant and equipment		24.0			Additional paid-in stockholders’ equity		10.8
					Retained earnings		8.0
Total	$	37.0			Total	$	37.0

a. What is the market debt-to-value ratio of the firm? I know the answer for this part which is 23.51%

b. What is University’s WACC?

(For all the requirements, do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

Answer 1

	Bonds (A)	15
	Preferred Stock (B)	3
	Common stock	0.2
	Additional paid-in stockholders’ equity	10.8
	Retained earnings	8
	Shareholders Equity Capital (C)	19
	Total Capital (A+B+C)	37
Source of capital	Formula for cost of capital	Cost of Capital	Capital amount ($ millions)	% weightage	weightage * cost
Bonds	Cost of debt (Post tax) = Pre-tax interest rate * (1- tax rate)	6%*(1-0.21)=4.74%	15	15/37 = 40.5405%	40.5405% * 4.74% = 1.9216%
Preferred stock	Cost of preferred stock = Dividend per share / Par value per share	3/20 = 15%	3	3/37 = 8.1081%	8.1081% * 15% = 1.2162%
Equity stock	Cost of equity = Risk free rate + Beta * (market premium)	8%+(0.7*12%) = 16.4%	19	19/37 = 51.3514%	51.3514% * 16.4% = 8.4216%
	WACC	= 1.9216% + 1.2162% + 8.4216%
	WACC	= 11.56%