Question

Titan Mining Corporation has 9.9 million shares of common stock outstanding, 430,000 shares of 6 percent preferred stock outstanding, and 225,000 8.7 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $47 per share and has a beta of 1.45, the preferred stock currently sells for $97 per share, and the bonds have 20 years to maturity and sell for 118 percent of par. The market risk premium is 8.7 percent, T-bills are yielding 5 percent, and the company’s tax rate is 40 percent.

a.	What is the firm’s market value capital structure? (Do not round intermediate calculations. Round your answers to 4 decimal places, e.g., 32.1616.)

	Market value weight
Debt
Preferred stock
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

Market Value of Debt = 225,000 * 1,000 * 1.18 = 265,500,000

Market Value of Equity = 9,900,000 * 47 = 465,300,000

Market Value of Equity = 430,000 * 97 = 41,710,000

So, the market value weights of the company’s financing is:

Debt/ Value of firm = 265,500,000/ (265,500,000 + 465,300,000 + 41,710,000)

Debt/ Value of firm = 0.34

Common Stock/ Value of firm = 465,300,000/ (265,500,000 + 465,300,000 + 41,710,000)

Common Stock/ Value of firm = 0.60

Preferred Stock/ Value of firm = 41,710,000/ (265,500,000 + 465,300,000 + 41,710,000)

Preferred Stock/ Value of firm = 0.05

Part B

For projects equally as risky as the firm itself, the WACC should be used as the discount rate.

First we can find the cost of equity using the CAPM.

The cost of equity is:

Cost of Equity = 5% + 1.45 * 8.7% = 17.62%

Cost of debt is the YTM of the bonds, so:

PV = 1,180

FV = 1,000

N = 20 * 2 = 40

PMT = 8.7% 1000 * 0.5 = 43.5

Using Financial Calculator:

I = 3.506287%

YTM = 7.01%

And the after tax cost of debt is:

After tax cost of debt = (1 - 0.40) * (7.01%)

After tax cost of debt = 4.21%

The cost of preferred stock is:

Cost of Preferred Stock = 6/ 97 = 6.19%

WACC = 17.62% * 0.60 + 4.21% *  0.34 + 6.19% * 0.05

WACC = 10.61% + 1.45% + 0.33%

WACC = 12.39%