Organic Produce Corporation has 8.6 million shares of common stock outstanding,

Question

Organic Produce Corporation has 8.6 million shares of common stock outstanding, 610,000 shares of 7.1 percent preferred stock outstanding, and 186,000 of 8.3 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $65.10 per share and has a beta of 1.31, the preferred stock currently sells for $106.90 per share, and the bonds have 16 years to maturity and sell for 90.5 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: What is the firm's market value capital structure? (Do not round intermediate calculations. Round your answers to 4 decimal places (e.g., 32.1616).) Market value weight of debt Market value weight of preferred stock Market value weight of equity What is the firm's cost of each form of financing? (Do not round intermediate calculations. Enter your answers as a percentage rounded to 2 decimal places (e.g., 32.16).) Aftertax cost of debt % Cost of preferred stock % Cost of equity % 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).) Weighted average cost of capital

Explanation / Answer

1) Firm's Market Value Capital Structure: # of shares Unit MV Capital or bonds MV Total MV Structure Common Stock 8600000 65.1 559860000 70.5647% Preferred Stock 610000 106.9 65209000 8.2189% Bonds 186000 905.0 168330000 21.2163% 793399000 2) Cost of each form of financing: Cost of equity - Ke: As per CAPM = 5.55 + 1.31*6.85 = 14.52% Cost of preferred stock - Kp = 7.1/106.9 = 6.64% Cost of debt - Kd: To be solved from the following equation-value of r to be found out. 905 = 1000*pvif(r,32) + 41.5*.7*pvifa(r,32) value of r is to be found out by trial and error: discounting with 3% 1000*0.3883 + 29.05*20.3888 = 388.3 + 592.29 = 980.59 discounting with 4% 1000*0.2851+29.05*17.8736 = 285.1 + 519.23 = 804.33 Exact value of r = 3 + 75.59/176.26 = 3.43 Annual rate = 3.43 *2 = 6.86% 3) WACC-the discount rate to be used: specific cost WACC % weight % Common Stock 14.52 70.5647% 10.25 Preferred Stock 6.64 8.2189% 0.55 Bonds 6.86 21.2163% 1.46 12.25 WACC = 12.25%. WACC is the discount rate to be used for the new project.

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