Question

Titan Mining Corporation has 7.5 million shares of common stock outstanding, 250,000 shares of 4.2 percent preferred stock outstanding, and 140,000 bonds with a semiannual coupon of 5.1 percent outstanding, par value $1,000 each. The common stock currently sells for $51 per share and has a beta of 1.15, the preferred stock currently sells for $103 per share, and the bonds have 15 years to maturity and sell for 107 percent of par. The market risk premium is 7.5 percent, T-bills are yielding 2.4 percent, and the company’s tax rate is 22 percent. What is the firm’s market value capital structure? 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?

Answer 1

Please see explanation.

Step-by-step explanation:

We will begin by finding the market value of each type of financing.

We find: MVD= 135,000($1,000)(1.14) = $153,900,000 MVE= 8,500,000($34) = $289,000,000 MVP= 250,000($91) = $22,750,000 And the total market value of the firm is: V = $153,200,900 + 289,000,000 + 22,750,000 = $465,650,000

So, the market value weights of the company’s financing is:D/V = $153,900,000/$465,650,000= .3305 P/V = $22,750,000/$465,650,000 = .0489 E/V = $289,000,000/$465,650,000 = .6206 b.

For projects equally as risky as the firm itself, the WACC should be used as the discount rate. First we can find the cost of equity using the CAPM. The cost of equity is: RE= .04 + 1.25(.075) = .13375 or 13.375% The cost of debt is the YTM of the bonds, so: P0= $1140 = $37.5(PVIFAR%,30) + $1,000(PVIFR%,30) R = 3.033% YTM = 3.033% × 2 = 6.066% And the aftertax cost of debt is: RD= (1 –.35)(.06066) = .039429 or 3.9429%

The cost of preferred stock is: RP= $5/$91 = .0549 or 5.49% Now we can calculate the WACC as: WACC = .039429(.3305) + .13375(.6206) + .0549(.0489) = .09872 or 9.872%