Question

Titan Corporation has 8.9 million shares of common stock outstanding and 330,000 5.3 percent semiannual bonds outstanding, with a par value of $1,000 each The common stock currently sells for $37 per share and has a beta of 115, the bonds have 15 years to maturity and sell for 118 percent of par. The market risk premium is 7.7 percent, T-bills are yielding 4 percent, and the company's tax rate is 24 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 and enter your answer as a percent
rounded to 2 decimal places, e.g., 32.16.)

Answer 1

The question involves determining the market value capital structure for Titan Corporation's equity and debt, and finding the firm's discount rate for new investments. The market value capital structure is calculated from the market price of common stock and the selling price of the bonds. The discount rate is the firm's weighted average cost of capital, which includes both cost of equity, derived from CAPM, and the after-tax cost of debt.

Step-by-step explanation:

The student has posed a finance related question that involves calculating the market value capital structure and the appropriate discount rate (cost of capital) for evaluating a new investment. To tackle part (a), the market values of equity and debt must be determined. The market value of common stock is calculated by multiplying the number of shares outstanding by the current market price per share. For the semiannual bonds, the market value is determined by multiplying the total number of bonds by their current selling price (as a percentage of the par value).

For part (b), the discount rate that should be applied to the project's cash flows is the firm's weighted average cost of capital (WACC). This accounts for the cost of equity and the after-tax cost of debt, weighted by the proportion of equity and debt in the firm's capital structure. The cost of equity can be derived using the Capital Asset Pricing Model (CAPM), which considers the risk-free rate, the equity beta, and the market risk premium. The after-tax cost of debt is calculated by adjusting the bond's yield for the corporation's tax rate.