Question

Twitter Corporation has 13 million shares of common stock outstanding, 900,000 shares of 9 percent preferred stock outstanding and 250,000 ten percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for Rs 34 per share and has a beta of 1.15, the preferred stock currently sells for Rs. 80 per share, and the cost of bonds is 11.20%. The market risk premium is 11.5 percent, T-bills are yielding 7.5 percent, and the firm's tax rate is 30 percent. What discount rate should the firm apply to a new project's cash flows if the project has the same risk as the firm's typical project? ( please answer step by step)

Answer 1

Solution :-

Cost of Equity = 7.5% + ( 1.15 * 11.5% ) = 20.725%

Cost of Bonds = 11.20% * ( 1 - 0.30 ) = 7.84%

Cost of Preference shares = $9 / $80 = 11.25%

Now Value of Equity = 13,000,000 * $34 = $442,000,000

Value of Bond = 250,000 * $1,000 = $250,000,000

Value of Preferred stock = 900,000 * $80 = $72,000,000

Total Value = $442,000,000 + $250,000,000 + $72,000,000 = $764,000,000

Weight of Equity = $442,000,000 / $764,000,000 = 57.85%

Weight of Debt = $250,000,000 / $764,000,000 = 32.72%

Weight of Preferred stock = $72,000,000 / $764,000,000 = 9.42%

Project Cost = ( 57.85% * 20.725% ) + ( 32.72% * 7.84% ) + ( 9.42% * 11.25% ) = 15.62%

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