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. Titan Mining Corporation has 9 million shares of common stock outstanding and 200,000 bonds outstanding...

. Titan Mining Corporation has 9 million shares of common stock outstanding and 200,000 bonds outstanding with 8 percent coupon rate, semiannual payments and par value $1,000 each. The common stock currently sells for $30 per share and has a beta of 1.20, and the bonds have 20 years to maturity and sell for 115 percent of par. The market risk premium is 6 percent, T-bills are 2 percent, and the company’s tax rate is 20 percent. If the company is evaluating a new investment project that has higher risk (beta of the project is 1.5) than the firm’s typical project, what rate should the firm use to discount the project’s cash flows?

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Answer #1
1] Before tax cost of debt = YTM.
YTM using a financial calculator = 6.63%
After tax cost of debt = 6.63%*(1-20%) = 5.30%
2] Debt/Equity ratio:
Equity = 9000000*30 = $     27,00,00,000 54.00%
Debt = 200000*1150 = $     23,00,00,000 46.00%
Total capital $     50,00,00,000 100.00%
Debt/equity ratio = 46/54 = 0.8519
3] Levered beta for the project = 1.5*(1+0.8*0.8519) = 2.52
4] Cost of equity for the project per CAPM = 2%+2.52*6% = 17.12%
5] Discount rate for the project = 5.30%*46%+17.12%*54% = 11.68%
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