Organic Produce Corporation has 8 million shares of common stock outstanding, 55
ID: 2750018 • Letter: O
Question
Organic Produce Corporation has 8 million shares of common stock outstanding, 550,000 shares of 7 percent preferred stock outstanding, and 180,000 of 8.2 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $64.50 per share and has a beta of 1.25, the preferred stock currently sells for $107.50 per share, and the bonds have 15 years to maturity and sell for 93.5 percent of par. The market risk premium is 6.8 percent, T-bills are yielding 5.5 percent, and the firm’s tax rate is 34 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., 32.1616).) 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
Ke= Rf + b(Rm-Rf)
=5.5% +1.25(6.8%)
=.055+.085
=14%
Therefore the market value of share = market price * no of shares outstanding = 8,million *64.5
Cost of debt = interest /100 = 8.2 % is the cost of debt
Therefore the cost of capital = cost of equity + cost of debt + cost of preferre stock
14%* weight of equity + 8.2%* weight of debt + 7%* weight of preferred stock
= total market value =755125000
weights are = .6833 for equity +.2383 for debts +.078 for preferred stock
Therefore cost of capital = 14%*.68+8.2%*.2383 + .07*.078
Hence it is = 12.06%
Therefore to select a proect one should discount at cost of capital structure rate
Common stock 8 million Preferred 550000 Debt 180000 Share price 64.5 beta 1.25 Preferred share price 107.5 bond selling price 93.5 Rm- rf 6.8 Rf 5.5 Therefore cost of equity using CAPM modelRelated Questions
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