Question

Titan Mining Corporation has 6.3 million shares of common stock outstanding, 220,000 shares of 3.6 percent preferred stock outstanding, and 105,000 bonds with a semiannual coupon rate of 5.3 percent outstanding, par value of $1,000 each. The common stock currently sells for $73 per share and has a beta of 1.15, the preferred stock has a par value of $100 and currently sells for $83 per share, and the bonds have 17 years to maturity and sell for 107 percent of par. The market risk premium is 7.1 percent, T-bills are yielding 3.1 percent, and the company’s tax rate is 23 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., .1616.)

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 enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

The firm’s market value capital structure is $503,910,000.

The rate the firm should use to discount the project’s cash flows is 9.33%.

a.

We will begin by finding the market value of each type of financing. We find:

Market value of debt = MVD = 105,000*($1,000)*(1.07) = $25,750,000

Market value of preferred cost = MVP = 220,000*($83) = $18,260,000

Market value of equity = MVE = 6,300,000*($73) = $459,900,000

And the total market value of the firm is:

V = $25,750,000 + 18,260,000+ 459,900,000

V = $503,910,000

b.

So, the market value weights of the company's financing are:

D/V = $25,750,000/$503,910,000 = 0.0511

P/V = $18,260,000/$503,910,000 = 0.0362

E/V = $459,900,000/$503,910,000 = 0.9127

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 = .031 + 1.15(.071)

RE = 0.1030, or 10.03%

The cost of debt is the YTM of the bonds, so:

P0 = $1,070 = $26.50(PVIFAR%,34) + $1,000(PVIFR%,34)

R = 2.228%

YTM = 2.228% × 2

YTM = 4.46%

And the aftertax cost of debt is:

RD = (1 - .22)(.0446)

RD = .0348, or 3.48%

The cost of preferred stock is:

RP = $3.60/$73

RP = .0493, or 4.93%

Now we can calculate the WACC as:

WACC = 0.0511(.0348) + 0.0362(.0493) + 0.9127(.1003)

WACC =0.0933, or 9.33%

Hence, The firm’s market value capital structure is $503,910,000.

The rate the firm should use to discount the project’s cash flows is 9.33%.

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