Question

Titan Mining Corporation has 9 million shares of common stock outstanding and 340,000 6 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $38 per share and has a beta of 1.5, and the bonds have 20 years to maturity and sell for 119 percent of par. The market risk premium is 7.8 percent, T-bills are yielding 3 percent, and the company’s tax rate is 36 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.)

	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 and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Discount rate

%

Answer 1

a). Market Value of Equity = No. of Shares x Share Price

= 9,000,000 x $38 = $342,000,000

Market Value of Debt = No. of bonds x price quote x par value

= 340,000 x 119% x $1,000 = $404,600,000

Total Market Value = Market Value of Equity + Market Value of Debt

= $342,000,000 + $404,600,000 = $746,600,000

Debt % = Market Value of Debt / Total Market Value = $404,600,000 / $746,600,000 = 0.5419

Equity % = Market Value of Debt / Total Market Value = $342,000,000 / $746,600,000 = 0.4581

b). According to the CAPM,

kE = rF + beta[E(rM) - rF]

= 3% + 1.5[7.8%] = 3% + 11.7% = 14.7%

To find the kD, we need to put the following values in the financial calculator:

INPUT	20x2=40		-(119% x 1,000) = -1,190	(6%/2)x1,000=30	1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT		2.27

So, r = 2.27%

Hence, YTM = 2r = 2 x 2.27% = 4.54%

WACC = [wD x kD x (1 - t)] + [wE x kE]

= [0.5419 x 4.54% x (1 - 0.36)] + [0.4581 x 14.7%]

= 1.58% + 6.73% = 8.31%