Suppose a firm has 10.4 million shares of common stock outstanding
with a par value of $1.00 per share. The current market price per
share is $12.00. The firm has outstanding debt with a par value of
$56.0 million selling at 102% of par. What capital structure weight
would you use for debt when calculating the firms weighted average
cost of capital (WACC)?
Please show all work!!!!

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Request for Question Clarification by omnivorous-ga on 01 Dec 2003 07:48 PST

Pheifer --

This question has a piece to it that makes it and your other WACC
question (#282075) difficult to answer -- that's the market value of
the debt and the market value of the equity.

In reality, most firms use balance sheet numbers for equity and debt
to determine WACC.  Balance sheet numbers and market value are often
very different due to growth rates of the firm (for equity) and
interest rate changes (for debt).

In addition, capital costs are considered to be approximations -- so
it's rare that a company will adjust either debt or equity numbers to
today's stock or bond prices.

I would solve this problem using debt at par; stock at market -- but
only because I don't have any other option.  Others may argue that
debt should be adjusted to market if equity's at market; that view is
not incorrect.

I guess what I'm saying is that there are two possible correct answers
here.  That implies AT LEAST two possible correct answers for #282075.

Best regards,

Omnivorous-GA

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Clarification of Question by pheifer-ga on 01 Dec 2003 09:20 PST

I'm not exactly sure which way the question should be answered, but it
is multiple choice. The choices are,
A. o.157
b. 0.314 
c. 0.686
d. 0.739
e. 0.843

I hope this helps. Which ever way you can answer this problem is
probably the same way the other WACC questions should be answered.
I'll look and see if the other question is a multiple choice too.
Thankyou so much for your help!

Pheifer --

Par values for stock are the lowest price at which is can be sold (an
issue in sales, option contracts or potentially even as gifts), so
it's unimportant in finance questions, except when reconstructing
balance sheet elements.

So, equity is $124.8 million.

Debt is $57.12 million in this case.  They've adjusted the par value
to real-market interest rates -- which companies often do once each
year to match market interest rates.

So, total capital = $181.92 million; debt = $57.12M/$181.92M = 31.4%.

Best regards,

Omnivorous-GA