Question

Makai Metals Corporation has 8.3 million shares of common stock outstanding and 270,000 5 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $31 per share and has a beta of 1.15, and the bonds have 15 years to maturity and sell for 112 percent of par. The market risk premium is 7.1 percent, T-bills are yielding 4 percent, and the company’s tax rate is 30 percent. a. What is the firm's market value capital structure? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.) Market value weight Debt Equity b. If the company is evaluating a new investment project that has the same risk as the firm's typical project, what rate should the firm use to discount the project's cash flows? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Discount rate %

Answer 1

Requirement (a) – Firm’s Market Value Capital Structure

Capital	Calculation	Market Value Capital Structure Weights
Debt	[$30,24,00,000 / 55,97,00,000]	0.5403
Equity	[$25,73,00,000 / 55,97,00,000]	0.4597

Market Value of each capital Structure

Debt = $30,24,00,000 [270,000 x ($1,000 x 112%)]

Equity = $25,73,00,000 [83,00,000 x $31]

Total Market Value = $55,97,00,000

Requirement (b) – The Rate to Discount the Project’s cash flows.

Cost of Debt

Cost of Debt = Yield to Maturity (YTM)

Yield to Maturity [YTM] = Semiannual Coupon Amount + [(Face Value – Bond Price) / Maturity Years] / [(Face Value + Bond Price)/2]

= [{$25 + [($1,000 – 1,120) / 30 Years)}] / [($1,000 + 1,120) / 2] x 100

= [($25 – 4) / 1,060] x 100

= 1.965%

Semiannual YTM =1.965%

Annual YTM = 3.93% [1.965% x 2]

After Tax Cost of Debt = Bond’s YTM x [ 1 – Tax Rate]

= 3.93% x (1 – 0.30)

= 3.93% x 0.70

= 2.75%

Cost of Equity

Cost of Equity = Rf + [B x Risk Premium]

= 4% + [1.15 x 7.10%]

= 4% + 8.17%

= 12.17%

The Rate to Discount the Project’s cash flows

Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt x Weight of Debt] + [Cost of equity x Weight of Equity]

= [2.75% x 0.5403] + [12.17% x 0.4597]

= 1.49% + 5.59%

= 7.08%

“The Rate to Discount the Project’s cash flows = 7.08%”