The current market rate of return is 12% and the risk-free rate is 4%. You have been given the job of determining your firm's cost of capital components. The company has 1 million shares outstanding with a current value of $22.50 per share. The debt represents 30% of the capital structure and the yield to maturity is 12%. The b of the equity is 1.4 and the tax rate if 30%. What is the firm's market value of debt and equity respectively?
A) 22,500,000; 6,750,000
B) 2,020,000; 22,500,000
C) 4,750,000; 15,750,000
D) 9,642,857; 15,750,000
E) 9,642,857; 22,500,000

Question

Quizplus · Accepted Answer

The market value of equity is calculated as the number of shares outstanding multiplied by the current value per share, which is 1,000,000 * $22.50 = $22,500,000. The debt represents 30% of the capital structure, implying that equity represents 70%. If the equity is $22,500,000 and represents 70%, the total market value of the firm is $22,500,000 / 0.7 = $32,142,857. The market value of the debt is then the total value minus the equity value, which is $32,142,857 - $22,500,000 = $9,642,857.

The Current Market Rate of Return Is 12% and the Risk-Free