Question

Titan Mining Corporation has 8.5 million shares of common stock outstanding and 250,000 5.2 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $34 per share and has a beta of 1.25; the bonds have 15 years to maturity and sell for 114 percent of par. The market risk premium is 7.5 percent, T-bills are yielding 4 percent, and the company’s tax rate is 21 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., .3216.)
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 and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

   

a. Debt Equity b. Discount rate %

  

Answer 1

a

MV of equity=Price of equity*number of shares outstanding

MV of equity=34*8500000

=289000000

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=1000*250000*1.14

=285000000

MV of firm = MV of Equity + MV of Bond

=289000000+285000000

=574000000

Weight of equity = MV of Equity/MV of firm

Weight of equity = 289000000/574000000

W(E)=0.5035 = equity

Weight of debt = MV of Bond/MV of firm

Weight of debt = 285000000/574000000

W(D)=0.4965 = debt

b

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 4 + 1.25 * (7.5)

Cost of equity% = 13.38

Cost of debt

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =15x2

1140 =∑ [(5.2*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^15x2

k=1

YTM = 3.9537720497

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 3.9537720497*(1-0.21)

= 3.123479919263

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=3.12*0.4965+13.38*0.5035

WACC =8.29%