Makai Metals Corporation has 8.5 million shares of common stock outstanding and

Question

Makai Metals Corporation has 8.5 million shares of common stock outstanding and 250,000 5 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $34 per share and has a beta of 1.25, and the bonds have 15 years to maturity and sell for 114 percent of par. The market risk premium is 7.5 percent, T-bills are yielding 4 percent, and the company’s tax rate is 35 percent.

a. What is the firm's market value capital structure?
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

a. cost of equity = 4 + 7.5*1.25 = 13.375%

for cost of debt

N = 30

FV = 1000

PV = -1140

PMT = 25

use rate function in Excel and multiply by 2* (1- 0.35)

b. discount rate = 7.95%

Market value weight cost weight*cost equity           289,000,000 0.5035 13.38% 0.0673 debt           285,000,000 0.4965 2.45% 0.0122

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