Hankins Corporation has 7.6 million shares of common stock outstanding, 510,000
ID: 2824921 • Letter: H
Question
Hankins Corporation has 7.6 million shares of common stock outstanding, 510,000 shares of 7.1 percent preferred stock outstanding, and 176,000 of 8.3 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $64.10 per share and has a beta of 1.21, the preferred stock currently sells for $107.90 per share, and the bonds have 16 years to maturity and sell for 95.5 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.
a. What is the firm's market value capital structure? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.)
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? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Weighted average cost of capital %
Explanation / Answer
Market value of common stock = 7,600,000 * 64.1 = 487,160,000
Market value of Preferred stock = 510,000 * 107.9 = 55,029,000
Market value of debt = 176,000 * ( 95.5% of 1000) = 168,080,000
Total market valur of capital structure = 487,160,000 + 55,029,000 + 168,080,000 = $710,269,000
Market value weight of debt = 168,080,000 / 710,269,000 = 0.2366
Market value weight of preferred stock = 55,029,000 / 710,269,000 = 0.0775
Market value weight of equity = 487,160,000 / 710,269,000 = 0.6859
b)
Cost of preferred stock = 7.1%
Cost of equity using CAPM method = risk free rate + beta ( amrket risk premium)
Cost of equity = 0.0555 + 1.21 ( 0.0685)
Cost of equity = 0.138385 or 13.8385%
Price of bond = 95.5% of 1,000 = $955
Coupon payment = 0.083 * 1000 = 83 / 2 = 41.5 ( since it is a semi annual bond, we divide by 2)
Number of periods = 16 * 2 = 32
Before tax cost of debt using a financial calculator = 8.83%
Keys to use in a financial calculator: 2nd I/Y 2, FV = 1000, PV = -955, N = 32, PMT = 41.5, CPT I/Y
After tax cost of debt = 0.0883 ( 1 - 0.3)
After tax cost of debt = 0.06181 or 6.181%
Weighted average cost of capital = Weigth of equity * cost of equity + weight of debt * cost of debt + weight of preferred stock * cost of preferred stock
Weighted average cost of capital = 0.6859 * 0.138385 + 0.2366 * 0.06181 + 0.0775 * 0.071
Weighted average cost of capital = 0.094918 + 0.014624 + 0.005503
Weighted average cost of capital = 0.115045 or 11.50%
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