Valley Tech Inc. has the following capital components in its capital structure:
ID: 2671278 • Letter: V
Question
Valley Tech Inc. has the following capital components in its capital structure:Book Value ($m) Market value
Debt $ 750 $ 800
Preferred stock 50 60
Common equity 1000 1140
Total $1,800 $2,000
Management’s stated target capital structure proportions are 40%, 5% and 55% for debt preferred stock, and common stock, respectively.
Comparable companies have the following capital components in market value terms (millions of $):
X Y Z
Debt $ 500 $ 800 $ 600
Preferred stock 0 200 100
Common equity 1,500 1,000 700
Total $2,000 $2,000 $1,400
Determine, using three different methods, the weights that could be used in Valley Tech’s WACC.
Explanation / Answer
The best weights are the company’s stated weights of 40% debt, 5% preferred stock and 555 equity. The second best choice is to find the targeted capital structure based on market values using the structure: Weight of debt (WD) = $800/$2,000 = 0.40 = 40% Weight of preferred stock (WP) = $60/$2,000 = 0.03 = 3% Weight of common equity (WCE) = $1,140/$2,000 = 0.57 = 57% The final method is to use the comparables. The averages are used as the weights: X Y Z Average Debt 0.25 0.40 0.43 0.36 Preferred stock 0.00 0.10 0.07 0.06 Common Equity 0.75 0.50 0.50 0.58 Total 1.00 1.00 1.00 1.00
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