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? 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?

Explanation / Answer

a)

Conclusion:-

b) Cost of debt = 3.85 (NOTE 1) * (1 - 0.40) = 2.31 %

   Cost of preferred stock = 5 %

   Cost of equity = Risk free rate + Beta * market risk premium

= 4 + 1.45 * 7.7

= 15.165 %

Calculation of weighted average cost of capital:-

Weighted average cost of capital = 9.95 % (approx)

Conclusion:- The firm should use 9.95 % as a discount rate to discount the cash flows of project.

(NOTE 1):- Coupon rate on bond = 7.7 / 2 = 3.85 % (Semi-annual bond).

Particulars Total market value Market value weight Debt = 175000 * 1000 * 1.18 206500000 206500000 / 564510000 = 0.3658 Preferred stock= 330000 * 87 28710000 28710000 / 564510000 = 0.0509 Equity = 8900000 * 37 329300000 329300000 / 564510000 = 0.5833 Total 564510000 1

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