Question

VN VeT SIde CA Consider risk m he form of Beto DDM aSSumes Burns Mining Corporation has 8 million shares of common stock, 400,000'prefetence shares cdel varu12.401 and 150,000 bonds outstanding. The bonds have 15 years to maturity and sell for 94 percent of ptagi par ($1,000). The relevant coupon rate is 6.5 percent and the bond pays semi-annually. 09Umes Common stock currently sells for $57 per share and has a beta of 1.25, The preference share YisR prE and BE currently sells for $78 per share, offering $5 fixed dividend and has a par value of $100. The market risk premium is 8 percent, T-bills are yielding 5.5 percent, and Burns Mining's tax rate is 34 percent. What is the market value of the firm's capital structure? (a) If Buns Mining is evaluatinga new investment project that has the same risk as the firm's (b) typical project, what rate should the firm use to discount the project's cash flows?

Answer 1

		MARKET VALUE OF THE FIRM'S CAPITALSTRUCTURE
		Bond:
		Market Price of each bond=94%*1000=	$940
		Number of Bonds outstanding	150000
		Total Market value of bonds=940*150000=	$141,000,000
		Market Price of each share of common stock	$57
		Number of shares of common stock outstanding	8000000
		Total Market value of Common stock=$57*8000000=	$456,000,000
		Market Price of each preference share	$78
		Number of preference shares outstanding	400000
		Total Market value preference shares=$78*400000=	$31,200,000
	a	Total Market value of bonds=9400*150000=	$141,000,000
	b	Total Market value of Common stock=$57*8000000=	$456,000,000
	c	Total Market value preference shares=$78*400000=	$31,200,000
	d=a+b+c+d	Market Value of Total Capital	$628,200,000
	Wb=a/d	Weight of Bond in the capital structure	0.22
	We=b/d	Weight of Common Shares in the capital structure	0.73
	Wp=c/d	Weight of Preference shares in the capital structure	0.05
	(b)	Discount Rate=Weighted Average Cost of Capital (WACC)
		WACC=Wb*Cb+Wp*Cp+We*Ce
		Wb=Weight of Bond in the total capital
		Wp=Weight of Preference Shares in the totalcapital
		We=Weight of Common Shares in the total capital
		Cb=Cost of bond
		Cp=Cost of Preference shares
		Ce=Cost of Common Shares
			AFTER TAX COSTS: Debt Face value of each Bond $1,000 Coupon Rate Semi annual Coupon Payment=1000*6.5 %* ( 1 /2) Number of payments 6.50% Pmt $32.50 (15 years*2) Nper 30 Pv Current marke Value of each Bond $940 Amount to paid at maturity Fy $1,000 Semi annual Yield To Maturity(Using RATE function of excel with Nper 30,Pmt 32.5,Pv-940,F=1000) 3.58% (Excel Command: RATE (30,32.5-940,1000) RATE Annual Interest Rate-3.58 2 7.16% After Tax Cost of Bond 7.16*(1-Tax Rate) 7.16*(1-0.34) 4.72% Cb Preference shares Annual Dividend-$5 $5.00 Market Value-$78 $78 Required Annual return 5/78 6.41% Cp Cost of Preference Shares=1.2/20= 6.41% Common Shares CAPM EQUATION:Rs -Required Return of stock Rs Rf+Beta*(Rm-Rf) Rf=riskfree rate-5.5% , Rm -REMarket risk Premium-8% , Beta 1.25 Rs 5.5+1.25*8= 15.50% 10 Ce Cost of Equity = 15.50% After Tax Weighted average Cost of Capital: WACC Wb*Cb+Wp*Cp+We Ce-0.22*4.72+0.05*6.41 +0.73*1 Discount Rate to be used 12.63 % 12,63% Lboota