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Titan Mining Corporation has 9.3 million shares of common stock outstanding and 260,000 6.8 percent semiannual...

Titan Mining Corporation has 9.3 million shares of common stock outstanding and 260,000 6.8 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $34 per share and has a beta of 1.2, and the bonds have 20 years to maturity and sell for 104 percent of par. The market risk premium is 7 percent, T-bills are yielding 3.5 percent, and Titan Mining's tax rate is 35 percent?

a. What is Titan's cost of debt?

b. What us Titan's cost of equity?

c. What is Titan's weighted average cost of capital (WACC) using market value weights?

d. What discount rate should Titan use to evaluate a new investment project that has the same risk as the firm's typical project?

Solutions

Expert Solution

Answer a.

Number of bonds outstanding = 260,000
Face Value = $1,000

Current Price = 104% * $1,000
Current Price = $1,040

Value of Debt = 260,000 * $1,040
Value of Debt = $270,400,000

Annual Coupon Rate = 6.80%
Semiannual Coupon Rate = 3.40%
Semiannual Coupon = 3.40% * $1,000
Semiannual Coupon = $34

Time to Maturity = 20 years
Semiannual Period to Maturity = 40

Let Semiannual YTM be i%

$1,040 = $34 * PVIFA(i%, 40) + $1,000 * PVIF(i%, 40)

Using financial calculator:
N = 40
PV = -1040
PMT = 34
FV = 1000

I = 3.22%

Semiannual YTM = 3.22%
Annual YTM = 2 * 3.22%
Annual YTM = 6.44%

Cost of Debt = Annual YTM
Cost of Debt = 6.44%

Answer b.

Number of shares outstanding = 9,300,000
Current Price = $34

Value of Equity = 9,300,000 * $34
Value of Equity = $316,200,000

Cost of Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Equity = 3.50% + 1.20 * 7.00%
Cost of Equity = 11.90%

Answer c.

Value of Firm = Value of Debt + Value of Common Stock
Value of Firm = $270,400,000 + $316,200,000
Value of Firm = $586,600,000

Weight of Debt = $270,400,000 / $586,600,000
Weight of Debt = 0.4610

Weight of Equity = $316,200,000 / $586,600,000
Weight of Equity = 0.5390

WACC = Weight of Debt * Cost of Debt * (1 - Tax Rate) + Weight of Equity *Cost of Equity
WACC = 0.4610 * 6.44% * (1 - 0.35) + 0.5390 * 11.90%
WACC = 8.34%

Answer d.

Titan should use WACC i.e., 8.34% as discount rate in order to evaluate a new investment project.

jeff jeffy answered 8 months ago

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