# Market Value Capital Structure Suppose the Schoof Company has this book value balance sheet: ...

## Question:

Market Value Capital Structure Suppose the Schoof Company has this book value balance sheet:

Current assets | $30,000,000 |

Current liabilities | $10,000,000 |

Fixed assets | 50,000,000 |

Long-term debt | 30,000,000 |

Common stock (1 million shares) | 1,000,000 |

Retained earnings | 39,000,000 |

Total assets | $80,000,000 |

Total claims | $80,000,000 |

The current liabilities consist entirely of notes payable to banks, and the interest rate on this debt is 8%, the same as the rate on new bank loans. These bank loans are not used for seasonal financing but instead are part of the company's permanent capital structure. The long-term debt consists of 30,000 bonds, each with a par value of $1,000, an annual coupon interest rate of 6%, and a 20-year maturity. The going rate of interest on new long-term debt, rd, is 10%, and this is the present yield to maturity on the bonds. The common stock sells at a price of $56 per share.

Calculate the firm's market value capital structure. Round your answers to two decimal places.

## Capital Structure

Capital structure is the proportion of different sources of long term capital (like equity share capital, preference share capital, debentures or bonds, long term loans, and retained earnings ).In other words, it is the combination of various long term sources of funds

## Answer and Explanation:

- Though current liabilities consist of notes payable which is short term debt, it will be included in capital structure since bank loans are apart of permanent capital structure.

The market value of bank loans will be $10,000,000

- Market value of long term bond can be calculated using the YTM (yield to maturity) formula.

{eq}YTM = \frac{I + \frac{FV- MP}{n}}{\frac{FV + MP}{2}} {/eq}

where YTM is yield to maturity, given as 10% or 0.10

*FV* is the face value of the bond, given as 1000

*I* is annual interest, which is 6% of 1000 = 60

*MP* is the market price of the bond, which is to be determined

*n* is number of years to maturity, given as 20

- Plugging the values, we get

{eq}0.10 = \frac{60 + \frac{1000 - MP}{20}}{\frac{1000 + MP}{2}} {/eq}

{eq}0.10 = \frac{(1200 + 1000 - MP) / 20}{(1000 + MP) / 2} {/eq}

0.10 = {(2200 - *MP*) / 20 } * {2 / (1000 + *MP*)}

0.10 = (2200 - *MP*) / 10(1000 + *MP*)

0.10 = (2200 - *MP*)/(10,000 + 10*MP*)

0.10 (10,000 + 10*MP*) = 2200 - *MP*

1000 + *MP* = 2200 - *MP*

2*MP* = 1200

*MP* = $600

- Market value of long term debt = $600 * 30,000 bonds = $18,000,000
- Market value of common equity = $56 * 1million shares = $56,000,000

The market value weights is shown below

Type of capital | Market value | Weights |
---|---|---|

Bank loans | $10,000,000 | 0.12 |

Long term Debt | $18,000,000 | 0.21 |

Equity | $56,000,000 | 0.67 |

Total | $84,000,000 | 1 |

- Weights are calculated as market value of each type of capital divided by total capital. For example , 10,000,000 / 84,000,000 = 0.12

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from Finance 101: Principles of Finance

Chapter 15 / Lesson 1