Question

Raymond Mining Corporation has 8.4 million shares of common stock outstanding, 280,000 shares of 6 percent $100 par value preferred stock outstanding, and 141,000 7.50 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $32 per share and has a beta of 1.20, the preferred stock currently sells for $94 per share, and the bonds have 20 years to maturity and sell for 113 percent of par. The market risk premium is 7.2 percent, T-bills are yielding 5 percent, and Raymond Mining’s tax rate is 40 percent.

a. What is the firm’s market value capital structure? (Round the final answers to nearest dollar amount.)

Debt: $ ?

Equity: $ ?

Preferred stock: $ ?

b. If Raymond Mining 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? (Do not round intermediate calculations. Round the final answer to 3 decimal places.)

Discount rate: ? %

Answer 1

a)	Component	Market Value	Weight
	Debt-Bonds (141000*1130)	$ 15,93,30,000	35.06%
	Common stock (8400000*32)	$ 26,88,00,000	59.15%
	Preferred stock (280000*94)	$     2,63,20,000	5.79%
	Total	$ 45,44,50,000	100.00%
b)	Cost of debt:
	Before tax cost of debt = YTM.
	YTM (using an online calculator) =	6.34%
	After tax cost of debt = 6.34%*(1-40%) =	3.80%
	Cost of preferred stock:
	= 6/94 =	6.38%
	Cost of equity per CAPM:
	= 5%+1.20*7.2% =	13.64%
	WACC:
	Component	Market Value	Weight	Component Cost	WACC
	Debt-Bonds	$ 15,93,30,000	35.06%	3.80%	1.33%
	Common stock	$ 26,88,00,000	59.15%	13.64%	8.07%
	Preferred stock	$     2,63,20,000	5.79%	6.38%	0.37%
	Total	$ 45,44,50,000	100.00%		9.771%
	WACC = 5.899%
	As the new investment project has the same risk as the existing projects, the discount rate
	to be used is the WACC, which is 9.771%.