Titan Mining Corporation has 8.8 million shares of common stock outstanding and
ID: 2730824 • Letter: T
Question
Titan Mining Corporation has 8.8 million shares of common stock outstanding and 320,000 4 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $36 per share and has a beta of 1.4, and the bonds have 10 years to maturity and sell for 117 percent of par. The market risk premium is 7.6 percent, T-bills are yielding 5 percent, and the company’s tax rate is 38 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., 32.1616.) Weight Debt 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 and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
Explanation / Answer
a)
MVD = 320,000($1,000)(1.17) = $374,400,000
MVE = 8,800,000($36) = $316,800,000
And the total market value of the firm is:
V = $374,400,000 + 316,800,000 = $691,200,000
So, the market value weights of the company’s financing is:
D/V = $374,400,000/$691,200,000 = .5417
E/V = $316,800,000/$691,200,000 = .4583
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 = .05 + 1.4(.076) = .1564or 15.64%
The cost of debt is the YTM of the bonds, so:
P0 = $1170 = $20(PVIFAR%,20) + $1,000(PVIFR%,20)
By trial and error method or by using financial calculator we can find out the R.
R = 1.05%
YTM = 1.05% × 2 = 2.1%
After tax cost of debt is=(1--.38)(.021)
=.01302 or 1.302%
Now WACC is:
WACC=.01302(.5417)+.1564(.4583)
=.0788 or 7.88%
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