3. The Cost of Capital [25 Marks] Titan Mining Corporation has 8 million shares of equity outstanding and 1,200,000 bonds outstanding, each with a par value of 100 and 8.5% semi- annual coupon payments. The equity currently sells for 35 per share and has a beta of 1.2, and the bonds have 15 years to maturity and sell for 95% of par value. The YTM of the bonds is 9%. The expected return on the market portfolio is 12% and the risk-free rate is 2%. Titan Mining's tax rate is 25%. a) Calculate the company's after-tax weighted average cost of capital. [6 Marks] b) Discuss the advantages and disadvantages of using the capital asset pricing model (CAPM) for finding the cost of equity. [6 Marks] c) Titan Mining is evaluating a new investment project that has the same risk as the firm's typical project. The new project costs 14 million and will generate year-end cash flows of 3.2 million for 15 years. Compute the project's NPV and explain whether the company should take on the project. [5 Marks] d) If the overall firm WACC were used as the hurdle rate for all divisions, would the riskier divisions or the more conservative divisions tend to get most of the investment projects? Explain your answer using a relevant graph. [8 Marks] 3. The Cost of Capital [25 Marks] Titan Mining Corporation has 8 million shares of equity outstanding and 1,200,000 bonds outstanding, each with a par value of 100 and 8.5% semi- annual coupon payments. The equity currently sells for 35 per share and has a beta of 1.2, and the bonds have 15 years to maturity and sell for 95% of par value. The YTM of the bonds is 9%. The expected return on the market portfolio is 12% and the risk-free rate is 2%. Titan Mining's tax rate is 25%. a) Calculate the company's after-tax weighted average cost of capital. [6 Marks] b) Discuss the advantages and disadvantages of using the capital asset pricing model (CAPM) for finding the cost of equity. [6 Marks] c) Titan Mining is evaluating a new investment project that has the same risk as the firm's typical project. The new project costs 14 million and will generate year-end cash flows of 3.2 million for 15 years. Compute the project's NPV and explain whether the company should take on the project. [5 Marks] d) If the overall firm WACC were used as the hurdle rate for all divisions, would the riskier divisions or the more conservative divisions tend to get most of the investment projects? Explain your answer using a relevant graph. [8 Marks]
