Question

Titan Mining Corporation has 8.6 million shares of common stock outstanding, 300,000 shares of preferred stock outstanding, and 160,000 bonds outstanding with a par value of $1,000 each. The common stock currently sells for $34 per share and has a beta of 1.30, the preferred stock currently sells for $84 per share, and the bonds sell for 115 percent of par. The cost of common equity is 12.62 percent, preferred equity is 5.95 percent, and the debt's yield to maturity is 5.88. The company’s marginal tax rate is 40 percent. a. Use the market values to calculate the firm's capital structure weights. (Do not round intermediate calculations. Leave as a decimal and round your answers to 4 decimal places, e.g., 0.1616.) Market value weight Debt Preferred stock Equity 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? Note: You don't need to convert the yield to maturity to an EAR. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Discount rate %

Answer 1

Cost of equity = 12.62%

Cost of preferred stock = 5.95%

Before tax cost of debt = 5.88%

After tax cost of debt = 0.0588 ( 1 - 0.4) = 0.3528 or 3.53%

Market value of equity = 8,600,000 * 34 = 292,400,000

Market value of preferred stock = 300,000 * 84 = 25,200,000

Market vaue of debt = 160,000 * ( 115% of 1000) = 184,000,000

Total market value = 292,400,000 + 25,200,000 + 184,000,000 = 501,600,000

Weight of equity = 292,400,000 / 501,600,000 = 0.58

Weight of preferred stock = 25,200,000 / 501,600,000 = 0.05

Weight of bonds = 184,000,000 / 501,600,000 = 0.36

WACC = weight of equity * cost of equity + weight of preferred stock * cost of preferred stock + weight of bonds * cost of bonds

WACC = 0.58 * 0.1262 + 0.05 * 0.0595 + 0.36 * 0.0353

WACC = 0.073196 + 0.002975 + 0.0127

WACC = 0.088871 or 8.89%

If the company is evaluating a new project, comapnay will use 8.89% as the discount rate.