Titan Mining Corporation has 8.8 million shares of common stock outstanding, 320
ID: 2727530 • Letter: T
Question
Titan Mining Corporation has 8.8 million shares of common stock outstanding, 320,000 shares of 4 percent preferred stock outstanding, and 170,000 7.6 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $36 per share and has a beta of 1.40, the preferred stock currently sells for $86 per share, 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.
Explanation / Answer
a. What is the firm’s market value capital structure?
Number
Market value
Total market value
Market value structure
Debt
170,000
$ 1,170
$ 198,900,000
36.61%
Equity
8,800,000
$ 36
$ 316,800,000
58.32%
Preferred stock
320,000
$ 86
$ 27,520,000
5.07%
$ 543,220,000
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?
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 = Risk free rate + Beta*market risk premium = 0.05 + 1.40(.076) = 0.1564 or 15.64%
The cost of debt is the YTM of the bonds, so:
Price of bond = (Coupon payment*present value of annuity factor) + (Face value*Present value factor)
$1170 = $38(PVIFAR%,20) + $1,000(PVIFR%,20)
Solving above, R = 2.69%
This is semi-annual rate,
Annual YTM = 2.69%*2 = 5.38%
And the aftertax cost of debt is:
RD = (1 – 0.38)(.0538) = .0334 or 3.34%
The cost of preferred stock is:
RP = Dividend/Market price = $4/$86 = .0465 or 4.65%
Now we can calculate the WACC as:
WACC = (0.1564*58.32%) + (0.0538*36.61) + (0.0465*5.07%) = .1133 or 11.33%
Number
Market value
Total market value
Market value structure
Debt
170,000
$ 1,170
$ 198,900,000
36.61%
Equity
8,800,000
$ 36
$ 316,800,000
58.32%
Preferred stock
320,000
$ 86
$ 27,520,000
5.07%
$ 543,220,000
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