Independence Mining Corporation has 7 million shares of common stock outstanding
ID: 2732869 • Letter: I
Question
Independence Mining Corporation has 7 million shares of common stock outstanding, 1 million shares of 6% preferred stock outstanding, and 100,000 9% semiannual bonds outstanding, par value $1000 each. The common stock currently sells for $35 per share and has a beta of 1.0, the preferred stock currently sells for $60 per share, and the bonds have 15 years to maturity and sell for 89% of par. The market risk premium is 8%, T- bills are yielding 7%, and Independence Mining’s tax rate is 34%. a. What is the firm’s market value capital structure? b. If Independence 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?
Explanation / Answer
a. Market value capital structure:
b. Computation of WACC:
The weighted average cost of capital is 18.04%
Independence Mining should discount the cash flows of a new project with the same risk profile as the firm's typical project at 18.04%
* Cost of equity = Rf + b x Market risk premium = 7% + 1 x 8% = 15%
** Approximate yield to maturity of bonds =5.23%
After tax interest rate on bonds = 5.23 x (1-0.34) = 3.4518%
Source of capital Number of shares/bonds Market value per unit Market value of capital Common stock 7,000,000 $ 35 $245,000,000 6% Preferred Stock 1000,000 $ 60 $ 60,000,000 9% Bonds 100,000 $ 890 $ 89,000,000 $ 394,000,000