Titan Mining Corporation has 8.4 million shares of common stock outstanding and

Question

Titan Mining Corporation has 8.4 million shares of common stock outstanding and 280,000 6 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $32 per share and has a beta of 1.2, and the bonds have 20 years to maturity and sell for 113 percent of par. The market risk premium is 7.2 percent, T-bills are yielding 5 percent, and Titan Mining

Titan Mining Corporation has 8.4 million shares of common stock outstanding and 280,000 6 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $32 per share and has a beta of 1.2, and the bonds have 20 years to maturity and sell for 113 percent of par. The market risk premium is 7.2 percent, T-bills are yielding 5 percent, and Titan Mining

Explanation / Answer

WACC = E/V * Re + D/V * Rd * (1 - T)

E = Markert Value of Equity = 8.4 million shares * $32 per share = $268,800,000
D = Market Value of Debt = 280,000 bonds * $1000 * 113% = $316,400,000
V = E + D = $268,800,000 + $316,400,000 = $585,200,000

E/V = $268,800,000/$585,200,000 = 0.46
D/V = $316,400,000/$585,200,000 = 0.54

T = Corporate Tax Rate = 40% i.e. 0.4
(1 - T) = 1 - 0.4 = 0.6

Re, Cost of equity = Risk Free Return + Beta * Market Risk Premium = 0.05 + 1.2*0.072 = 0.1364
Rd, Cost of debt = 6% semiannual bonds = 0.06

Substituting the values,
WACC = E/V * Re + D/V * Rd * (1 - T)
WACC = 0.46 * 0.1364 + 0.54 * 0.06 * 0.6
WACC = 0.062744 + 0.01944 = 0.082184 i.e. 8.22%

If the new investment project has the same risk as the firm's typical project, the WACC rate should the firm use to discount the project's cash flows. Therefore, in this case, 8.22% should be used as the discount rate.

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