Question

Deep Mines has 43,800 shares of common stock outstanding with a beta of 1.54 and a market price of $51 a share. There are 10,000 shares of 7 percent preferred stock outstanding with a stated value of $100 per share and a market value of $83 a share. The 8 percent semiannual bonds have a face value of $1,000 and are selling at 96 percent of par. There are 5,000 bonds outstanding that mature in 13 years. The expected market rate of return is 7.5 percent, risk-free rate is 3.6 percent, and the tax rate is 21 percent. What discount rate should the firm apply to a new project's cash flows if the project has the same risk as the company's typical project? a. 9.3%. b. 8.4%. c. 7.7%. d. 10.7%.

Answer 1

Answer:

A. 9.3%

E = 43,800 ($51) = $2,233,800

P = 10,000 ($83) = $830,000

D = 5,000 ($1,000) (0.96) = $4,800,000

V = $2,233,800 + 830,000 + 4,800,000

V = $7,863,800

RE = 0.036 + 1.54 (0.075)

RE = 0.1515

RP = [0.07 ($100) ] / $83

RP = 0.0843

RD = 0.96 ($1,000) = [0.08 ($1,000) / 2] [(1 − {1 / [1 + (r / 2)] 13 (2) / (r / 2)] + $1,000 / [1 + (r/2) ] 13 (2)

RD = 0.0851

WACC =

($2,233,800 / $7,863,800) (0.1515) + ($830,000 / $7,863,800) (0.0843) + ($4,800,000 / $7,863,800) (0.0851) (1 − 0.21)

WACC =

0.0930, or 9.30%

Explanation:

MV of Equity = Price of Equity * Number of Shares Outstanding MV of Equity

$51 * 43,800 = 2,233,800 MV of Bond =

Par Value * Bonds Outstanding * % Age of Par MV of Bond =

$1,000 * 5,000 * 0.96 = 4,800,000 MV of Preferred Equity