Organic Produce Corporation has 9.3 million shares of common stock outstanding,

Question

Organic Produce Corporation has 9.3 million shares of common stock outstanding, 680,000 shares of 7.3 percent preferred stock outstanding, and 193,000 of 8.5 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $65.80 per share and has a beta of 1.38, the preferred stock currently sells for $106.20 per share, and the bonds have 14 years to maturity and sell for 87 percent of par. The market risk premium is 6.95 percent, T-bills are yielding 5.65 percent, and the firm’s tax rate is 40 percent.

(a) What is the firm's market value capital structure? (Do not round intermediate calculations. Round your answers to 4 decimal places (e.g., 32.1616).) 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?

Explanation / Answer

a)Market value of debt = 193000 * 1000 *.87 = 167,910,000          [par value = $1000]

Market value of preferred stock = 680,000 * 106.2 = $ 72,216,000

Market value of equity = 9,300,000*65.8 = 611,940,000

Total market value = 852,066,000

weight of debt = 167,910,000/ 852,066,000= 19.71%

weight of preferred = 72,216,000/852,066,000= 8.48%

weight of equity = 611,940,000 / 852,066 .000 = 71.81%

b)Cost of debt:Yield = [I+(Face value -pricE)/years/[(face value+price)/2]

            = [42.5 + (1000-870)/28 ]/[(1000+870)/2]

           = [42.5 + 4.64] / [1870/2]

           = 47.14/ 935

            = ..0504 or 5.04% semiannually

Annual yield = 5.04*2 = 10.08%

after tax yield = 10.08 (1-.40) = 6.05%

**Interest = 1000*.085 *6/12 = 42.5

semiannual months = 14*2 =28

issue price = 1000*.87 =870

cost of preferred stock = dividend /price

                               = (100*.073 ) / 106.20

                                = 7.3 / 106.2 = 6.87%

cost of equity = Rf+[B* Market Premium]

                       = 5.65 + [1.38 *6.95]

                       = 5.65 + 9.59

                        = 15.24%

Discount rate = [After tax yield on bond *Wd]+[Cost of preferred stock *Wp]+[Cost of equity *We]

             = [6.05 * .1971]+ [6.87*.0848]+ [15.24*.7181]

             = 1.1925+ .5826+ 10.9438

             = 12.72%

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