Titan Mining Corporation has 8.9 million shares of common stock outstanding, 330

Question

Titan Mining Corporation has 8.9 million shares of common stock outstanding, 330,000 shares of 5 percent preferred stock outstanding, and 175,000 7.7 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $37 per share and has a beta of 1.45, the preferred stock currently sells for $87 per share, and 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 40 percent. a. What is the firm's market value capital structure? (Do not round intermediate calculations. Round your answers to 4 decimal places, e.g., 32.1616.) Market value Debt Preferred stock Equity 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.) Discount rate

Explanation / Answer

Solution:-

We will first find market value of each type of capital structure.

i) Value of common stock = Number of common stock *Market value

                                                   = 8,900,000*$37= $329,300,000

ii) Value of preferred stock = No. of preferred stock *current price

                                                   = 330,000*$87 = $28,710,000

iii) Value of debt = 175,000*$1000*118%= $206,500,000

The total market value of firm = $329,300,000+$28,710,000+$206,500,000

                                                       =$564,510,000

a) So, the market value weights of the company’s financing is

      Debt = Debt/value of firm = $206,500,000/$564,510,000=0.3658

       Preferred stock =Preferred stock/ Value of firm

                            = $28,710,000/$564,510,000= 0.0509

         Common stock = Common stock/Value of firm

                             = 329,300,000/$564,510,000=0.5833

b)For the project that has the same risk as firm's typical project WACC should be the discount rate .

i) Calculation of cost of equity by CAPM model

Ke=Rf+?× Market risk premium.

    =4%+1.45×7.7% =15.165%

ii) Calculation of cost of debt

   The cost of debt is the YTM of the debt.

P0= $1180 = $77*PVIFA(R%,30) + $1,000*PVIF(R%,30)

Using hit and trail method we get

R= 6.342%

YTM of the bond = 2*6.342%= 12.684%

After tax cost of debt = 12.684%*(1-0.40)=7.6104%

iii)Cost of preferred stock

           = preferred dividend/ current price

           =5/87= 5.7471%

WACC = After tax cost of debt*weight of debt+ Cost of preferred stock*Weight of preferred stock + Cost of common stock*weight of common stock

=7.6104*0.3658+5.7471*0.0509+15.165*0.5833

=11.92%

Hence the discount rate = 11.92%

Please feel free to ask if you have any query in the comment section.

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