Question

Titan Mining Corporation has 8.9 million shares of common stock outstanding, 330,000 shares of preferred stock outstanding, and 175,000 bonds outstanding with a par value of $1,000 each. The common stock currently sells for $37 per share and has a beta of 1.45, the preferred stock currently sells for $87 per share, and the bonds sell for 118 percent of par. A. The cost of common equity is 15.17 percent, preferred equity is 5.75 percent, and the debt's yield to maturity is 5.88. The company’s marginal tax rate is 40 percent. B. Use the market values to calculate the firm's capital structure weights (debt, Preferred stock, equity). 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? Note: You don't need to convert the yield to maturity to an EAR.

Answer 1

10.43%

Working:

a.
	Calculation of weight of component of Equity:
			Quantity	Per unit Price		Total Market Value
	Debt		1,75,000	$       1,180		$           20,65,00,000
	Preferred Stock		3,30,000	$             87		$             2,87,10,000
	Equity		89,00,000	$             37		$           32,93,00,000
	Total					$           56,45,10,000
	Weight of :
	Debt		$ 20,65,00,000	/		$           56,45,10,000	=	0.366
	Preferred Stock		$    2,87,10,000	/		$           56,45,10,000	=	0.051
	Equity		$ 32,93,00,000	/		$           56,45,10,000	=	0.583
	Total							1.000
b.
	After tax yield to maturity			=	Before tax yield to maturity*(1-Tax Rate)
				=	5.88*(1-0.40)
				=	3.53
c.	Calculation of Weighted Average cost of capital:
			Weight	Cost(%)		Weighted Cost (%)
	Debt		0.366	3.53		1.29
	Preferred stock		0.051	5.75		0.29
	Equity		0.583	15.17		8.85
	Total					10.43
	Thus, Weighted average cost of capital of 10.43 percent will be used as discount rate to evaluate cash flows from project.