Deep Mines has 14 million shares of common stock outstanding with a beta of 1.15

Question

Deep Mines has 14 million shares of common stock outstanding with a beta of 1.15 and a market price of $42 a share. There are 900,000 shares of 9 percent preferred stock outstanding valued at $80 a share. The 10 percent semiannual bonds have a face value of $1,000 and are selling at 91 percent of par. There are 220,000 bonds outstanding that mature in 17 years. The market risk premium is 11.5 percent, T-bills are yielding 7.5 percent, and the firm's tax rate is 32 percent. What discount rate should the firm apply to a new project's cash flows if the project has the same risk as the firm's typical project?

A.14.59 percent

B.14.72 percent

C.15.17 percent

D.15.54 percent

E.16.91 percent

Explanation / Answer

Deep Mines Details Common shares outstanding             14,000,000 Price per share                              42 Market value of common share           588,000,000 Risk free rate Rf 7.50% Market Risk Premium=Rm= 11.50% Stock Beta                          1.15 Required return of Stock =Rf+Rm*beta                                                    = 0.075+0.115*1.15                                                       = 20.73% So cost of Common stock 20.73% Outstanding Preference shares                   900,000 Dividend 9% Value of each preference share                              80 Market value of preference share             72,000,000 Cost of Preference share=9/80= 11.25% YTM formula = {Interest payment+(Face value-Market price)/Years to maturity}/(face value+2*market price)/3 Face value                        1,000 Market Price                           910 Years to maturity                              17 Annual interest                           100 Bonds outstanding                   220,000 Market value of bonds           200,200,000 Tax rate 32% YTM = [100+(1000-910)/17]/(1000+2*910)/3             =11.21 % So YTM of bond =11.21% Post Tax cost of debt=11.2%*0.68                                             =7.616% WACC calculation Details Market Value Weight of value Cost Weighted cost Common stock           588,000,000 68.4% 20.73% 14.18% Preference share             72,000,000 8.4% 11.25% 0.95% Debt           200,200,000 23.3% 7.62% 1.78% Total           860,200,000 16.90% So the Required discount rate is closest to 16.91%

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