Question

Titan Mining Corporation has 10.1 million shares of common stock outstanding and 440,000 4.4 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $48 per share and has a beta of 1.05; the bonds have 10 years to maturity and sell for 115 percent of par. The market risk premium is 8.8 percent, T-bills are yielding 5 percent, and the company’s tax rate is 25 percent.

  

a.	What is the firm's market value capital structure? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., .3216.)
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? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

a). Total market value of equities = 10.1 million * $48 = $484.8 million.

Total market value of bonds = 440,000*$1,000*115% = $506 million.

Total market value = $484.8 + 506 = $990.4 million.

Share of equities = 484.8/990.4 = 48.91%

Share of debts = 506 / 990.4 = 51.09%.

b). According to CAPM,

kE = rF + beta[MRP] = 5% + [1.05 x 8.8%] = 5% + 9.24% = 14.24%

To find the kD, we need to put the following values in the financial calculator:

INPUT	10*2=20		-115%*1,000=-1,150	(4.4%/2)*1,000=22	1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT		1.34

So, kD = 2r = 2 x 1.34% = 2.68%

WACC = [wD x kD x (1 - t)] + [wE x kE]

= [0.5109 x 2.68% x (1 - 0.25)] + [0.4891 x 14.24%]

= 1.03% + 6.97% = 8.00%