Question

Titan Mining Corporation has 6.8 million shares of common stock outstanding, 245,000 shares of 4.1 percent preferred stock outstanding, and 130,000 bonds with a semiannual coupon rate of 5.8 percent outstanding, par value $1,000 each. The common stock currently sells for $68 per share and has a beta of 1.20, the preferred stock has a par value of $100 and currently sells for $88 per share, and the bonds have 17 years to maturity and sell for 106 percent of par. The market risk premium is 7.6 percent, T-bills are yielding 3.6 percent, and the company’s tax rate is 23 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., .1616.)
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.)

Answer 1

a. Market Value of preferred Stock = 88 *245000 = 21,560,000
Market Value of Bond = 130000*106 = 13,780,000
Market Value of Equity =6,800,000*68 = 462,400,000
Total Market Value = 21,560,000 +13,780,000+462400000=497,740,000


Weight of Preferred Stock = 21,560,000/497,740,000 = 4.33%
Weight of Bond =13,780,000/497,740,000 = 2.77%
Weight of Equity =462400000/497,740,000 = 92.90%

Cost of equity = Risk free Rate + Beta*(Market Return - Risk Free Rate)=3.6%+1.2*7.6%= 12.72%
Cost of preferred Stock = 4.1%*100/88 = 4.6591%

Par value of Bond = 1000
Coupon = 5.5%*1000/2 = 27.50
PV = 1060
Maturity = 17
YTM using excel function=2*RATE(17,27.50,-1060,1000)= 4.64%


Discount Rate = Weight of Equity* Cost of equity + Weight of Preferred Stock* Cost of Preferred Stock +Weight of Debt*Cost of debt*(1-Tax Rate) =462400000/497,740,000*12.72%+21,560,000/497,740,000*4.6591%+13,780,000/497,740,000*4.64%*(1-23%) = 12.12%

Please discuss in case of doubt