You are on page 1of 3

# Solution: Requirement # 01: Capital structure of the Corporation based on market values Since capital structure is a mix of debt

and equity used by a firm, therefore we calculate the market value of Bonds, Preferred shares and common shares of the corporation to find the Capital structure based on market values. 1. Bonds Par value of bonds = Rs.1,000 Book value of bonds = Rs.10,000,000 No. of Bonds outstanding = 10,000,000 / 1,000 = 10,000 Now we calculate present value/bond using discount rate of 9% (the current yield to maturity on bonds) Coupon payments = 1,000 8% = 80 PV = 80 (PVIFA 9%, 10) + 1,000 (PVIF 9%, 10) = 80 (6.4177) + 1000 (0.4224) = 422.4 + 513.416 = 935.816 So market value per bond is Rs.935.816 Market value of outstanding bonds = No. of outstanding bonds Market value per bond Market value of outstanding bonds = 10,000 935.816 = Rs.9, 358,160 2. Preferred stocks Book value of preferred stocks = Rs.20,000,000 Par Value per share = Rs.20 Corporate Finance- FIN 622 Fall 2007 Assignment # 03 Virtual University of Pakistan 4 No. Of preferred shares outstanding = Rs.20,000,000 / Rs.20 = 100,000 Market value per share = Rs.15 Market value of outstanding preferred shares = 100,000 15 = Rs.1,500,000 3. Common Stocks No. of Common shares outstanding = 1,000,000 Market value per share = Rs.20 per share Market value of outstanding common shares = 1,000,000 20 = Rs.20,000,000 Capital Structure of the Corporation (Based on market values) So the required capital structure of the corporation based on current market values is as follow: Bonds Rs.9,358,160 Preferred Shares 1,500,000

Common Shares 20,000,000 Total Rs.30,858,160 Requirement # 02: Weighted Average Cost of Capital of the Corporation. Capital structure of the Corporation based on market values is (as calculated in Part.01) Bonds Rs.9,358,160 Preferred Shares 1,500,000 Common Shares 20,000,000 Total Rs.30,858,160 Corporate Finance- FIN 622 Fall 2007 Assignment # 03 Virtual University of Pakistan 5 Weightage of the debt and equity in the capital structure. Weightage of Debt = XD = 30,858,160 9,358,160 100 = 30.33% Weightage of Preferred Stocks = XP = 30,858,160 1,500,000 100 = 4.86% Weightage of Common Stocks = XC = 30,858,160 20,000,000 100 = 64.81% Market rate of returns on Bonds, Preferred stocks and Common stocks a. Rate of return on bonds = rD= 9% (Current yield to maturity of bonds) b. Rate of return on Preferred stocks: Dividend on preferred stocks = Rs.2.00 per share Market Price of Preferred Stocks = Rs.15 per share So rate of return on Preferred Stocks = rP = 15 2 100 = 13.33% c. Rate of return on Common Stocks : Risk free rate of return = rf = 6% Market risk premium = rm - rf = 10% Tax rate = Tx = 40% Value of Common Stocks beta = = 0.80 According to CAPM rC = rf + (rm - rf) Putting values in the above formula we have

rC = 6% + (10%) 0.80 Corporate Finance- FIN 622 Fall 2007 Assignment # 03 Virtual University of Pakistan 6 rC = 6% + 8% = 14% So return on common stocks is 14%. Weighted Average Cost of Capital WACC = XD rD (1 -TX) + XP rP + XC rC Putting values in the above formula we have WACC = (30.33%) (9%) (1 - 40%) + (4.86%) (13.33%) + (64.81%) ( 14%) WACC = (0.3033) (0.09) (0.60) + (0.0486) (0.1333) + (0.6481) (0.14) WACC = 0.0163782 + 0.006478 + 0.090734 WACC = 0.1136 or 11.36% So weighted average cost of capital of the corporation is 11.36%.