Question

Titan Mining Corporation has 7.8 million shares of common stock outstanding, 290,000 shares of 4.3 percent preferred stock outstanding, and 175,000 bonds with a semiannual coupon rate of 5.9 percent outstanding, par value $2,000 each. The common stock currently sells for $59 per share and has a beta of 1.05, the preferred stock has a par value of $100 and currently sells for $97 per share, and the bonds have 16 years to maturity and sell for 103 percent of par. The market risk premium is 6.8 percent, T-bills are yielding 3.5 percent, and the company’s tax rate is 22 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., .1616.) 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?

Answer 1

a). Bond Value = 175,000 x $2,000 x 1.03 = $360,500,000

Equity Value = 7,800,000 x $59 = $460,200,000

Preffered Value = 290,000 x $97 = $28,130,000

Total Value = Bond Value + Equity Value + Preferred Value

= $360,500,000 + $460,200,000 + $28,130,000 = $848,830,000

Weight of Bond = B/V = $360,500,000 / $848,830,000 = 42.4702%

Weight of Equity = E/V = $460,200,000 / $848,830,000 = 54.2158%

Weight of Preferrred = P/V = $28,130,000 / $848,830,000 = 3.3140%

b). According to CAPM,

Re = Rf + beta[E(Rm) - Rf]

= 3.5% + 1.05[6.8%] = 3.5% + 7.14% = 10.64%

For YTM, we need to put the following values in the financial calculator:

INPUT	16x2=32		2000x1.03=-2,060	(5.9%/2)x2000=59	2000
TVM	N	I/Y	PV	PMT	FV
OUTPUT		2.81%

Annual YTM = 2.81% x 2 = 5.61%

Kp = Annual Coupon Payments / Current Market Price = $4.3/$97 = 4.43%

WACC = [Wd x Kd x (1 - t)] + [Wp x Kp] + [We x Ke]

= [0.424702 x 5.61% x (1 - 0.22)] + [0.03140 x3 4.43%] + [0.542158 x 10.64%]

= 1.86% + 0.0015% + 5.77% = 7.63%