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%

You are given the following information for Watson Power Co. Assume the company’s tax rate is 30 percent.

You are given the following information for Watson Power Co. Assume the company’s tax rate is 30 percent.

Debt:	9,000 6.4 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 107 percent of par; the bonds make semiannual payments.
Common stock:	360,000 shares outstanding, selling for $54 per share; the beta is 1.10.
Preferred stock:	14,000 shares of 4 percent preferred stock outstanding, currently selling for $74 per share.
Market:	11 percent market risk premium and 4.4 percent risk-free rate.

What is the company's WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

WACC

%

 

Explanation:

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

MVD = 9,000($1,000)(1.07) = $9,630,000

MVE = 360,000($54) = $19,440,000

MVP = 14,000($74) = $1,036,000

And the total market value of the firm is:

V = $9,630,000 + 19,440,000 + 1,036,000

V = $30,106,000

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

RE = .044 + 1.10(.11)

RE = .1650, or 16.50%

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

P0 = $1,070 = $32.00(PVIFAR%,40) + $1,000(PVIFR%,40)

R = 2.902%

YTM = 2.902% × 2 = 5.80%

And the aftertax cost of debt is:

RD = (1 – .30)(.0580)

RD = .0406, or 4.06%

The cost of preferred stock is:

RP = $4 / $74

RP = .0541, or 5.41%

Now we have all of the components to calculate the WACC. The WACC is:

WACC = .0406(9.630 / 30.106) + .1650(19.440 / 30.106) + .0541(1.036 / 30.106)

WACC = .1214, or 12.14%

Notice that we didn’t include the (1 – TC) term in the WACC equation. We used the aftertax cost of debt in the equation, so the term is not needed here.