As a member of the Finance Department of Ranch Manufacturing,

As a member of the Finance Department of Ranch Manufacturing, your supervisor has asked you to compute the appropriate discount rate to use when evaluating the purchase of new packaging equipment for the plant. Under the assumption that the firm’s present capital structure reflects the appropriate mix of capital sources for the firm, you have determined the market value of the firm’s capital structure as follows:

Source of CapitalMarket Values

Bonds ............$4,000,000

Preferred stock ........$2,000,000

Common stock ........$6,000,000

To finance the purchase, Ranch Manufacturing will sell 10-year bonds paying interest at a rate of 7 percent per year (with semiannual payments) at the market price of $1,050. Preferred stock paying a $2.00 dividend can be sold for $25. Common stock for Ranch Manufacturing is currently selling for $55 per share and the firm paid a $3 dividend last year. Dividends are expected to continue growing at a rate of 5 percent per year into the indefinite future. If the firm’s tax rate is 30 percent, what discount rate should you use to evaluate the equipment purchase?


Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on...
Capital Structure
Capital structure refers to a company’s outstanding debt and equity. The capital structure is the particular combination of debt and equity used by a finance its overall operations and growth. Capital structure maximizes the market value of a...
Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal...
Dividend
A dividend is a distribution of a portion of company’s earnings, decided and managed by the company’s board of directors, and paid to the shareholders. Dividends are given on the shares. It is a token reward paid to the shareholders for their...

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