Titan Mining Corporation has 9.7 million shares of common stock outstanding, 410,000 shares of 4 percent preferred stock outstanding, and 215,000 8.5 percent semiannual bonds outstanding, par value $1,000 each.

Titan Mining Corporation has 9.7 million shares of common stock outstanding, 410,000 shares of 4 percent preferred stock outstanding, and 215,000 8.5 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $45 per share and has a beta of 1.35, the preferred stock currently sells for $95 per share, and the bonds have 10 years to maturity and sell for 116 percent of par. The market risk premium is 8.5 percent, T-bills are yielding 5 percent, and the company’s tax rate is 35 percent.

a.	What is the firm’s market value capital structure? (Do not round intermediate calculations. Round your answers to 4 decimal places, e.g., 32.1616.)

	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? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Discount rate

%

 

Explanation:

a.

We will begin by finding the market value of each type of financing. We find:

MVD = 215,000($1,000)(1.16) = $249,400,000

MVE = 9,700,000($45) = $436,500,000

MVP = 410,000($95) = $38,950,000

And the total market value of the firm is:

V = $249,400,000 + 436,500,000 + 38,950,000 = $724,850,000

So, the market value weights of the company’s financing are:

D/V = $249,400,000 / $724,850,000 = .3441

P/V = $38,950,000 / $724,850,000 = .0537

E/V = $436,500,000 / $724,850,000 = .6022

b.

For projects equally as risky as the firm itself, the WACC should be used as the discount rate.

First we can find the cost of equity using the CAPM. The cost of equity is:

RE = .05 + 1.35(.085)

RE = .1648, or 16.48%

The cost of debt is the YTM of the bonds, so:

P0 = $1,160 = $42.50(PVIFAR%,20) + $1,000(PVIFR%,20)

R = 3.159%

YTM = 3.159% × 2 = 6.32%

And the aftertax cost of debt is:

RD = (1 – .35)(.0632)

RD = .0411, or 4.11%

The cost of preferred stock is:

RP = $4 / $95

RP = .0421, or 4.21%

Now we can calculate the WACC as:

WACC = .3441(.0411) + .0537(.0421) + .6022(.1648)

WACC = .1156, or 11.56%