Question

12/13

Titan Corporation has 10 million shares of common stock outstanding with a price of 29.4 per share.

Covariance between stock returns of Titan and returns of S&P 500 index is 0.95; and the variance of returns of S&P 500 is 0.9. The market return is 10%, and the T-bills are yielding 4%. Titan's tax rate is 30%.

Titan currently has 40,000 7% semi-annual coupon bonds outstanding (Par value =1,000). The bonds will mature in 15 years and are currently priced at $1,000 per bond

1.What is Titan's cost of debt? Show your work carefully.

2.What is the beta of Titan's stock ? Please show your work carefully.

3.What is Titan's cost of equity? Show your work carefully.

4.What is Titan's WACC? Show your work carefully.

Answer 1

(a) Calculation of cost of debt:

Since the Bond is valued at par therefore Cost of debt is calculated as follow:

Cost of debt (Kd) = Interest rate*(1-tax rate)

= 7*(1-.30)

= 4.9%

(b) Beta of the security = Covariance with the market portfolio/Variance of the market return

= 0.95/0.90

=1.0556

(c) Cost of equity using CAPM = Rf + β*(Rm - Rf)

= 4 + 1.0556*(10-4)

= 4 + 6.33

= 10.33%

(d) WACC = Wd*Kd+We*Ke

Market value of Equity = 10 Millions * $29.4 = $ 294 Millions

Market value of Bond = 40000 * $1000 = $ 40 Millions

= (40/334*4.9)+(294/334*10.33)

= 0.59+9.09

= 9.68%