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?

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

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?

Answer #1

Value of common Stock=Number of Shares*Share Price =4300000*58
=249400000

Total Value =67084550+249400000 =316484550

a. Weight of Debt/Value =67084550/316484550 =**0.2120 or
21.20%**

b.Weight of Equity/Value =249400000/316484550=**0.7880 or
78.80%**

c.

Cost of Equity using CAPM =Risk free Rate+Beta*Market Risk Premium
=5%+0.9*7% =11.3%

Discount Rate =Weight of Equity*Cost of Equity+Weight of
Debt*YTM*(1-Tax Rate)

=249400000/316484550*11.3%+67084550/316484550*9%*(1-35%)
=**10.14%**

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