Question

Raymond Mining Corporation has 9.4 million shares of common stock outstanding, 380,000 shares of 4% $100 par value preferred stock outstanding, and 161,000 7.50% semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $42 per share and has a beta of 1.20, the preferred stock currently sells for $91 per share, and the bonds have 10 years to maturity and sell for 113% of par. The market risk premium is 8.2%, T-bills are yielding 3%, and Raymond Mining’s tax is 35%.

a. What is the firm’s market value capital structure? (Enter your answers in whole dollars.)

	Market value
Debt	$
Equity	$
Preferred stock	$

b. If Raymond Mining 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 percentage rounded to 3 decimal places.)

Discount rate______%

Answer 1

We first calculate the market value of all the securities (Debt, Equity and Preffered Shares) using the data given. Below is the table with market value calculated as number of securities * Price. The price of Equity and Preferred Stock were given. The price of Debt is 113% of par value of $ 1000 and hence the price is $ 1130. The weight of each of the security is calculated by dividing the market value of each security by total market value.

Type	Number of Securities	Price ($)	Market Value ($)	Weights as per Market Value
Debt	161000	1130	181930000	30%
Equity	9400000	42	394800000	65%
Preferred Stock	380000	91	34580000	6%
Total			611310000

Answer (a)

Cost of equity = rf + beta*market risk premium = 3% + 1.2*8.2% = 12.84%

Cost of Debt after tax = Cost of Debt *(1-Tax) =7.5%*(1-35%) = 4.875%

Cost of Preffered shares after tax = 4%

Using the market weights calculated in the answer (a) , we calculate the WACC as = Cost of Equity *E/ Total capital + Cost of Debt*(1-T)*D/ Total Capital + Cost of Preffered Shares*P/Total Capital = 12.84%*65%+4.875%*30%+4%*6% = 9.96% = WACC for the company and in case the company wants to take up any new project, this WACC will apply. Answer (b)

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