Questions 16 and 17 concern the information below. Patrick Company expects to ge

Question

Questions 16 and 17 concern the information below.

Patrick Company expects to generate cash flows of $120,000 per year forever. The firm's required return is 12%, the market value of debt is $700,000, the market value of preferred stock is $300,000 and the company has 100,000 shares of stock outstanding which sells for $10 per share. Beta for this stock is 1.6, the rish-free rate of return is 2.25% and the market risk premium (rm-rf) is 5.5%

16) The proportion of debt in Patrick's capital structure is:

A) 30% B) 50% C) 70% D) indeterminate

17) The required return of Patrick's stock is:

A) 10.9% B) 7.75% C) 5.5% D) 2.25%

Explanation / Answer

Answer:16) D) indeterminate

Total merket value of the firm=700000+300000+(100000*10)

=$2000000

Proportion of debt=700000/2000000=35%

Answer:17)

R=Rf+beta(Equity risk premium)

=2.25%+1.6(5.5%)

=11.05%

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