A company has 10.1 million shares of common stock outstanding, 450,000 shares of 5 percent preferred stock outstanding, and 235,000 8.9 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $49 per share and has a beta of 1.55, the preferred stock currently sells for $99 per share, and the bonds have 15 years to maturity and sell for 116 percent of par. The market risk premium is 8.9 percent, T-bills are yielding 4 percent, and the company’s tax rate is 38 percent.
a. What is the firm's market value capital structure?
b. If the company is evaluating a new investment project that has the same risk as to the firm's typical project, what rate should the firm use to discount the project's cash flows?

total market value is $812.05  million

WACC project discount rate is 8.77%

Explanation:

The firm's market value is the sum of the market values of equity,debt and preferred stock.

Equity=10.1*$49=$494.9 million

debt=235,000*$1000*116%=$272.6 million

preferred stock=450,000*$99=$44.55 million

Total market value                      $812.05  million

WACC=Ke*E/V+Kd*D/V*(1-t)+Kp*P/V

Ke is the cost of equity=4%+1.55(8.9%-4%)=11.60%

Kd= rate(30,$1000*8.9%/2,-$1000*116%,1000)=3.57% semiannually

kd=3.57%*2=7.14%

Kp=5%

WACC=(11.50%*494.9/812.05)+(7.14%*272.6/812.05*(1-0.38)+(5%*44.55/812.05)=8.77%

rational decision making is a multi-step process for making choices between alternatives. the process of rational decision making favors logic, objectivity, and analysis over subjectivity and insight. the word “rational” in this context does not mean sane or clear-headed as it does in the colloquial sense.

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