Question

Raymond Mining Corporation has 8.4 million shares of common stock outstanding, 280,000 shares of 6 percent $100 par value preferred stock outstanding, and 141,000 7.50 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $32 per share and has a beta of 1.20, the preferred stock currently sells for $94 per share, and the bonds have 20 years to maturity and sell for 113 percent of par. The market risk premium is 7.2 percent, T-bills are yielding 5 percent, and Raymond Mining’s tax rate is 40 percent.

a. What is the firm’s market value capital structure? (Round the final answers to nearest dollar amount.)

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. Round the final answer to 3 decimal places.)

Discount rate: ? %

Answer 1

MV of equity=Price of equity*number of shares outstanding

MV of equity=32*8400000

=268800000

MV of Bond=Par value*bonds outstanding*%age of par

MV of Bond=1000*141000*1.13

=159330000

MV of Preferred equity=Price*number of shares outstanding

MV of Preferred equity=94*280000

=26320000

MV of firm = MV of Equity + MV of Bond+ MV of Preferred equity

=268800000+159330000+26320000 =

=454450000

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 5 + 1.2 * (7.2)

Cost of equity% = 13.64

Cost of debt

K = Nx2

Bond Price =∑ [(Semi Annual Coupon)/(1 + YTM/2)^k]     +   Par value/(1 + YTM/2)^Nx2

k=1

K =20x2

1130 =∑ [(6*1000/200)/(1 + YTM/200)^k]     +   1000/(1 + YTM/200)^20x2

k=1

YTM = 4.9671232262

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 4.9671232262*(1-0.4)

= 2.98027393572

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 6/94*100

=6.38

Weight of equity = MV of Equity/MV of firm

Weight of equity = 268800000/454450000

W(E)=0.5915

Weight of debt = MV of Bond/MV of firm

Weight of debt = 159330000/454450000

W(D)=0.3506

Weight of preferred equity = MV of preferred equity/MV of firm

Weight of preferred equity = 26320000/454450000

W(PE)=0.0579

WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=2.98*0.3506+13.64*0.5915+6.38*0.0579

WACC% = 9.48