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 Debt =Number of Bonds*Price of Bond =85000*789.23=67084550
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%[phone]/316484550*9%*(1-35%) =10.14%