Organic Produce Corporation has 9.1 million shares of common stock outstanding,

Question

Organic Produce Corporation has 9.1 million shares of common stock outstanding, 660,000 shares of 7.1 percent preferred stock outstanding, and 191,000 of 8.3 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $65.60 per share and has a beta of 1.36, the preferred stock currently sells for $106.40 per share, and the bonds have 16 years to maturity and sell for 88 percent of par. The market risk premium is 6.85 percent, T-bills are yielding 5.55 percent, and the firm?s tax rate is 30 percent. Required: (a) What is the firm?s market value capital structure? (Do not round intermediate calculations. Round your answers to 4 decimal places (e.g., 32.161 6).) Market value weight of debt Market value weight of preferred stock Market value weight of equity (b) If the firm is evaluating a new investment project that has the same risk as the firm?s typical project, what rate should the firm use to discount the project?s cash flows? (Do not round intermediate calculations. Enter your answer as a percentage rounded to 2 decimal places (e.g., 32.16).)

Explanation / Answer

Solution:

A) Market value weight of debt = 191,000 x 1,000 x 1.36

                          = $259,760,000 million

B) Market value weight of Preffered Stock =660,000 x 106.40

                                   = $70,224,000 million

C) Market value weight of Equity = 9.1 million x 65.60

                            =$ 596,960,000 million

Firm’s market value capital structure = Market value weight of debt +Market value weight of Preferred Stock +Market value weight of Equity

        = $259,760,000 million+ $70,224,000 million+$ 596,960,000 million

        = $ 926,944,000 million

B) The market value weights of the company's financing

Debt/Firm value = 259,760,000 / 926,944,000

             =  27.699%

        

Equity/Firm value = 596,960,000 / 926,944,000

               = 64.40%

Preferred/Firm value =70,224,000 / 926,944,000

                 = 7.575%

Ke = Rf + beta x risk premium

Ke = 0.0555 + 1.36 x 0.0685

Ke =0.0555 + 0.09316

Ke = 14.866%

Kd = YTM post tax

PV = $880

FV= $1,000.00

Maturity = 32

YTM= 3% ? (By using Trial and Error)

Kd = 5.81%

Kp = Preferred dividend/current price

Kp = 7.1 / 106.40

Kp = 6.67%

Cost of debt post tax = 5.81%

Weight of debt =  27.699%

Cost of equity = 14.866%

Weight of equity= 64.40%

Cost of preferred stock= 6.67%

Weight of preferred stock = 7.575%

WACC = cost of debt post tax * weight of debt + cost of preferred stock * weight of preferred stock + cost of equity x weight of equity

WACC = 5.81% x 27.699% +6.67% x 7.575% +14.866% x 64.40%

      = 160.93 + 50.525 + 957.3704

      = 1,168.8254

      = 11.68%

  

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