he market risk premium for FCIB is 9 percent, and has a tax rate of 35 percent. The risk-free rate of interest is 5%. Willow-Woods Inc. has a capital structure comprised of the following: 8,500,000 shares of common stock outstanding, 200,000 shares of 7 percent preferred stock outstanding, and 85,000, 8.5 percent semiannual bonds outstanding, par value of $1,000 each. The common stock currently sells for $34 per share and has a beta of 1.2, the preferred stock currently sells for $83 per share, and the bonds have 15 years to maturity and sell for 93 percent of par. a) What is the market value of Willow-Woods’ capital structure? b) What rate should Willow-Woods should use to discount the cash flows of a new investment project that has the same risk as the company’s typical project?
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Question 3
The market risk premium for FCIB is 9 percent, and has a tax rate of 35 percent. The risk-free
rate of interest is 5%.
Willow-Woods Inc. has a capital structure comprised of the following:
8,500,000 shares of common stock outstanding,
200,000 shares of 7 percent
85,000, 8.5 percent semiannual bonds outstanding, par value of $1,000 each.
The common stock currently sells for $34 per share and has a beta of 1.2, the preferred stock currently sells for $83 per share, and the bonds have 15 years to maturity and sell for 93 percent of par.
a) What is the market value of Willow-Woods’ capital structure?
b) What rate should Willow-Woods should use to discount the cash flows of a new investment project that has the same risk as the company’s typical project?
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