A firm has S10 million common equity on the balance sheet Th

A firm has S10 million common equity on the balance sheet. The firm\'s stock price is $25/share and the firm has 1 million outstanding shares of stock. The firm has no preferred stock. The firm has total debt at a book value of $30 million but interest rate changes have increased the value of the debt to a current market value of $35 million. To compute WACC of the firm, the weight for equity should be and the weight for debt should be Select one: ? a. 25%,75% ? b. 45%; 55% E c. 22%,78% C d. 42% 589 C e, 55% 45% Feedback Your answer is incorrect. The correct answer is: 42%; 58%

Solution

Equity:

Number of shares outstanding = 1,000,000
Market Value per share = $25

Market Value of Equity = Number of shares outstanding * Market Value per share
Market Value of Equity = 1,000,000 * $25
Market Value of Equity = $25,000,000

Debt:

Market Value of Debt = $35,000,000

Total Market Value of Firm = Market Value of Equity + Market Value of Debt
Total Market Value of Firm = $25,000,000 + $35,000,000
Total Market Value of Firm = $60,000,000

Weight of Equity = Market Value of Equity / Total Market Value of Firm
Weight of Equity = $25,000,000 / $60,000,000
Weight of Equity = 42%

Weight of Debt = Market Value of Debt / Total Market Value of Firm
Weight of Debt = $35,000,000 / $60,000,000
Weight of Debt = 58%