I am having some difficulties with week four lab. The explanation for problem skips a step and I do not know how to get the answer.
(Weighted average cost of capital). As a member of the Finance Department of Ranch Manufacturing, your supervisor has asked you to compute the appropriate discount rate to use when evaluating the purchase of new packaging equipment for the plant. Under the assumption that the firm’s present capital structure reflects appropriate mix of capital sources for the firm, you have determined the market value of the firm’s capital structure. As follows:
Bonds: 4,300,000 Bonds, preferred stock and common stock prices given: not the
Preferred stock: 2,200,000 the total. I added them, and determined the weights below for
Common Stock 6,200,000 each item. (which matches the answers provided.
Total value 12,700,000
Determining weights
Debt/bonds: 4,300,000/12,700,000 = .03385 or 34%
Preferred stock 2,200,000/12,700,000 = 0.1732 or 17%
Common Stock 6,200,000/12,700,000 = 0.0488 or 49%
Then it states:
To finance the purchase, Ranch Manufacturing will sell 10-year bonds paying 7.3% at the market price of $1,058. Preferred stocks paying a $2.08 dividend can be sold for $25.57. Common stock for Ranch Manufacturing is currently selling for $55.23 per share and the firm paid a $3.12 dividend last year. Dividends are expected to continue growing at a rate of 5.4% per year into the indefinite future. If the firm’s tax rate is 30%, what discount rate should you use to evaluate the equipment purchase?
To calculate the yield to maturity on a bond we can use the time value of money features on a financial calculator.
Here are the numbers they used for the calculator.
10 N I/Y -1,058 PV 73 PMT 1,000 FV
ANSWER: I/Y= 6.49
10 equals the number of years for the N function -1,058 equals the market price for the PV function, 7.3% equals 73 for the PMT function
1,000 equals the FV. I do not understand where they get the 1,000 for the FV It does not mention anywhere in the information provided what the par value (face value).
The rest of the problem I can figure out. It’s just this one section I am stuck on. Can you explain the steps for this part please?
please explain to me how to get the figure for Weights
Bonds are sold in $1,000 demoninations
To calculate the yield to maturity (YTM) on a bond, you need to utilize the time value of money calculations. The YTM represents the expected return from the bond if it is held until maturity.
In the given information, it mentions that Ranch Manufacturing will sell 10-year bonds paying 7.3% at a market price of $1,058. To calculate the YTM, you can use the following financial calculator input:
10 (N) - This is the number of years until the bond matures.
-1,058 (PV) - This represents the present value, which is the market price of the bond.
73 (PMT) - This is the periodic interest payment on the bond. Since the bond pays 7.3%, which is $73 per year (7.3% of $1,000 face value), you input 73.
1,000 (FV) - This is the future value or the face value of the bond.
Now, you mentioned that there is no information provided about the par value (face value). Typically, the face value of a bond is $1,000, which is a common convention. In the absence of information, you can assume a face value of $1,000 for the bond.
After inputting these values into the financial calculator, you can solve for the YTM, which represents the discount rate that equates the present value of the bond's cash flows to its market price. In this case, the YTM is calculated to be 6.49%.
Therefore, the discount rate (or weighted average cost of capital) to evaluate the equipment purchase for Ranch Manufacturing would be 6.49%.