Junior Interiors market value capital structure of 62% Common Equity, 3% Preferr
ID: 2711073 • Letter: J
Question
Junior Interiors market value capital structure of 62% Common Equity, 3% Preferred Stock (PS) and 35% Debt. The company does not pay dividends, and evaluates its operations as approximately 30% more risky than an “average” company in the industry. The overall rate of return on average industry investments is 8.4% and risk-free investments currently return 1.7%.
Company Bonds sell for 97% of $2,000,000 Face value; carry a 6% annual interest rate with interest only payments made monthly. Currently outstanding debt obligations are due in 4 years. The firm’s PS has a current annual yield of 7.1%. It applicable tax rate is 32%.
a) What is Juniors Weighted Average Cost of Capital (WACC)?
b) If the regular PS dividend is $1.35 per quarter, for what does the stock currently sell?
c) A firm has a target Debt to Equity ratio of .85. It WACC is 10.2% and the applicable tax rate is 35%. If the company Cost of Equity is 13.4%, what is its PRE-TAX Cost of Debt?
d) Stock B has a Beta of 1.1 and an expected return of 12.3%. If the risk-free rate is 3.7% and MRP is 7%, is Stock B priced correctly?
Explanation / Answer
ANSWER:
n = 10, = 54000, s = 15000
Lower limit = 43,269.443, and upper limit = 64,730.557
We must assume that the population distribution of salaries is normal, especially since the sample size is so small.
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