Question 5t Jim Mining Company Limited has 8.5 million shares of common stock ou

Question

Question 5t

Jim Mining Company Limited has 8.5 million shares of common stock outstanding. 250,000, 5% preferred shares outstanding and 135,000, 7.5 percent semi-annual bonds outstanding, par value $1,000 each. The common stock currently sells for $34 and has a beta of 1.25. The preferred stock currently sells for $91 per share and the bond have 15 years to mature and sells for 114 percent of par. The market risk premium is 7.5 %, T bills are yielding 4 percent and Jim’s tax rate is 35 percent.

a) What is firm’s market capital structure?

b) If Jim is evaluating new investment projects that have then same risk as the firm’s typical project, what rate should the firm use to discount the project’s cash flows?

Explanation / Answer

a)Common stock value=$8.5×34=$289m

Preferred shares o/s =$.25×91=$22.75m

Bonds o/s value=$.135×1140=$153.9m

Total value=$754.65m

Equity weight=289/754.65=.38

Preferred stock weight=.03

Bond weight=.20

b)Re=Rf+MRP×Beta =4+7.5×1.25=13.375%

Preference shareholders reqd return=5%

Int rate on bond=7.5%

Weighted average=.13375×.38+.05×.03+.075×.2=6.762%.This is the rate used to discount project cash flows.

Thank you.

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