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The market price of Albertson Ltd.'s common stock is $5.50, and 100,000 shares are outstanding....

Question:

The market price of Albertson Ltd.'s common stock is $5.50, and 100,000 shares are outstanding. The firm's books show common equity accounts totaling $400,000. There are 5,000 preferred shares outstanding that originally sold for their par value of $50, pay an annual dividend of $3, and are currently selling to yield an 8% return. Also, 200 bonds are outstanding that were issued 5 years ago at their $1,000 face values for 30-year terms, pay a coupon rate of 7%, and are currently selling to yield 10%.

Develop Albertson's capital structure based on both book and market values. Are they significantly different? If so, comment on the implications.

Capital structure and WACC:

Capital structure can be calculated using both book and market values. However, when calculating WACC, it is far better to take market value estimates to avoid major estimation errors when calculating the present value of cash flows.

Answer and Explanation: 1

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First, calculate the book value of capital structure:

Equity = $400,000

Preferred equity = 5,000 x $50 = $250,000

Bonds = 200 x $1,000 = $200,000

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