Titan Mining Corporation has 8.9 million shares of common stock outstanding and

Question

Titan Mining Corporation has 8.9 million shares of common stock outstanding and 330,000 5 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, 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? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.) Weight Debt Equity 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

Part A)

The market value capital structure is determined as follows:

Market Value of Bond = Number of Bonds*Face Value*Current Selling Price = 330,000*1,000*118% = $389,400,000

Market Value of Common Stock = Number of Common Shares*Current Selling Price = 8,900,000*37 = $329,300,000

Market Value of Firm = 389,400,000 + 329,300,000 = $718,700,000

_____

Now, we can calculate the weights as follows:

Weight of Debt = 389,400,000/718,700,000 = .5418

Weight of Equity = 329,300,000/718,700,000 = .4582

_______

Part B)

To calculate the discount rate, we need to find the cost of debt and equity to find the value of WACC as follows:

Cost of Debt:

The cost of debt can be calculated with the use of Rate function/formula of EXCEL/Financial Calculator. The function/formula for Rate is Rate(Nper,PMT,-PV,FV) where Nper = Period, PMT = Coupon Payment, PV = Bond Price and FV = Face Value of Bonds.

Here, Nper = 15*2 = 30, PMT = 1,000*5%*1/2 = $25, PV = 1,000*118% = $1,180 and FV = $1,000 [we use 2 since the bond is semi-annual]

Using these values in the above function/formula for Rate, we get,

After-Tax Cost of Debt = Rate(30,25,-1180,1000)*2*(1-40%) = 2.07%

_____

Cost of Equity

The cost of equity can be calculated as follows:

Cost of Equity = Risk Free Rate + Beta*Market Risk Premium = 4% + 1.45*7.7% = 15.17%

_____

Now, we can calculate the WACC (Discount Rate) as follows:

WACC = After-Tax Cost of Debt*Weight of Debt + Cost of Equity*Weight of Equity

Using the values calculated above, we get,

WACC (Discount Rate) = 2.07%*.5418 + 15.17%*.4582 = 8.07%

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