Question

#16 a Finding the WACC Adex Mining Corporation has 9 million shares of common stock outstanding, 250,000 shares of 6 percent preferred stock outstanding, and 105,000 7.5 percent semi-annual bonds outstanding, par value $1,000 each. The common stock currently sells for $34 per share and has a beta of 1.25, the preferred stock currently sells for $91 per share, and the bonds have 15 years to maturity and sell for 93 percent of par. The market risk premium is 8.5 percent, T-bills are yielding 5 percent, and Adex Mining's tax rate is 35 percent. What is the firm's market value capital structure? If Adex Mining 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?

Answer 1

Market value = 426,400,000

Discount rate to be used = 12.8%

Type	Market value	Market value weights [ Individual / Total]
Common stock	306000000	0.717636023
Preferred stock	22750000	0.053353659
Debt	97650000	0.229010319
Market value of the capital structure	426400000

Market value weights	Individual cost	WACC {weights * cost}
0.717636023	15.625%	11.21%
0.053353659	6.59%	0.35%
0.229010319	5.41%	1.24%
Total		12.80%

Cost of debt using financial calculator:

NPER	30	[15*2]
FV	1000
PMT	37.5	[1000*7.5%*1/2]
PV	930.000
Rate	4.16%	[Rate ( nper, pmt,-pv,fv)]
YTM	8.33%	[4.16%*2]

After tax cost of debt = 8.33 % * ( 1-35%) = 5.41%

2. Cost of preferred stock = 6/ 91 = 6.59%

3. Cost of equity = 5% + 1.25 * 8.5% = 15.625%