Titan Mining Corporation has 9.1 million shares of common stock outstanding and

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

Explanation / Answer

Answer a.

MVD = 350,000($1,000)(1.10) = $385,000,000   

MVE = 9,100,000($39) = $354,900,000

And the total market value of the firm is:

V = $385,000,000 + 354,900,000 = $739,900,000

So, the market value weights of the company’s financing is:

D/V = $385,000,000/$739,900,000 = 0.5203

E/V = $354,900,000/$739,900,000 = 0.4797

Answer b.

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 = 0.05 + 1.55(0.079) = 0.1725 or 17.25%

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

P0 = $1100 = $20(PVIFAR%,20) + $1,000(PVIFR%,20)   

R = 1.37%

YTM = 1.37% × 2 = 3.74%

And the aftertax cost of debt is:

RD = (1 – 0.40)(0.0374) = 1.64%

Now we can calculate the WACC as:

WACC = 0.1725*0.4797 + 0.0164*0.5203 = 9.13%

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