Question

A Mining company has 4.3 million shares of common stock outstanding and 85,000 bonds outstanding, par value of $1,000 each. Each bond has a 6.8 percent annual coupon rate and the bonds have 23 years to maturity and is now selling at $789.23. (Based on the current price, its YTM is 9%) Coupon is paid annually. The common stock currently sells for $58.00 per share and has a beta of 0.90. The market risk premium is 7 percent and Treasury bills are yielding 5 percent and the company’s tax rate is 35 percent. a. What are the weight of debt component (D/V) in the firm’s capital structure? (Round up your answer to the nearest two decimal points and answer in percentage. eg.11.22% only put 11.22 in the blank)

b. What is the weight of equity component (E/V) in the firm’s capital structure?

(Round up your answer to the nearest two decimal points and answer in percentage. eg.11.22% only put 11.22 in the blank)

c.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?

(Round up your answer to the nearest two decimal points and answer in percentage. eg.11.22% only put 11.22 in the blank)

Answer 1

ANS=  

- Weight of debt component = market value of debt / Total value of firm's capital.

- Weight of equity component= market value of equity / total value of firm.    - Total value of firm capital= no. of bond outstanding x market price of bond + no. of share outstanding x current price  of share.

- Total value of firm capital = 85,000 x 789.23 + 4,300,000 x 58 = 316,484,550.

- market value of debt= 85000 x789.23 = 67,084,550.

- Market value of equity = 4,300,000 x 58 = 249,400,000.

Ans A)   Weight of debt = 67,084,550 / 316,484,550 = 0.2120 or 21.20%.

Ans B) Weight of equity = 249,400,000 / 316,484,550 = 0.7880 or 78.80%.

Ans C) Rate firm use to discount it's cashlow = 9.84%.

- Wacc = (weight of debt x after-tax cost of debt ) + (weight of equity x cost of equity)

- After tax cost of Debt= coupon rate x ( 1-tax) = 0.068 x (1- 0.35) = 0.0442 0r 4.42%.

- Cost of equity = Risk free rate + beta x ( market risk premuim) = 0.05 + 0.90 x (0.07) = 0.1130 or 11.30%.

- WACC = ( 0.2120 x 0.0442 ) + ( 0.7880 x 0.1130) = 0.0984 or 9.84 %.

# Wacc is the rate firm use to discount it's projected cashflow.