Question

Titan Mining Corporation has 9.1 million shares of common stock outstanding and 350,000 4 percent semiannual bonds outstanding, par value $1,000 each.
The common stock currently sells for $39 per share and has a beta of 1.55, and the bonds have 10 years to maturity and sell for 110 percent of par.
The market risk premium is 7.9 percent, T-bills are yielding 5 percent, and Titan Mining’s tax rate is 40 percent.

a. What is the firm's market value capital structure? (Do not round intermediate calculations and round your final answers to 4 decimal places. (e.g., 32.1616))b. If Titan Mining 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 round your final answer to 2 decimal places. (e.g., 32.16))

Answer 1

Answer:

Market value capital structure:

Market value of common stock = 9,100,000 x $39   = 354,900,000

Market value of bond                  = 350,000 x $1,100 = 385,000,000

Market value of the firm                                                  739,900,000

COST OF EQUITY

b. Ke = Rf + β(Rm-Rf)

   Ke = 5 + 1.55(7.9)

   Ke = 5 + 12.245

   Ke = 17.245%

   COST OF DEBT

    Coupon (R) = 4% x $1,000 = $40

    Par value (Pt) = $1,000

    Current price (Po) = $1,100

     No of years (n) = 10 years

      Tax rate (T) = 40% = 0.40

   Kd = R/m(1 - T) + (Pt -Po)1/n

                    (Pt+Po)1/2

   Kd = 40/2(1 - 0.4) + (1,000 - 1,100)1/10

                      (1,000+1,100)1/2

   Kd = 20(0.6) + (-100)0.1

                   (2,100)0.5

   Kd = 12 - 10

            1,050

   Kd = 0.00194047619 = 0.1904761904%

   

WACC = Ke(E/V) + Kd(D/V)

WACC = 17.245(354,900,000/739,900,000) + 0.1904761904(385,000,000/739,900,000)

WACC = 8.27 + 0.099

WACC = 8.37%

Explanation:

The firm's market value capital structure equals the market value of equity plus market value of bond.

Cost of equity is calculated based on CAPM formula, where Rf is the risk-free rate, Rm -Rf is market risk premium.

The cost of debt is also calculate using the formula stated above.

The weighted average cost of capital is the cost of each stock multiplied by the proportion of each stock in the capital structure.