Wacc, Corporate Finance

The cost of capital for a firm can differ from the cost of capital for each of its businesses. When a firm has multiple businesses, it is important to use the cost of capital appropriate to the particular project under consideration, rather than the firm''s overall cost of capital, when evaluating a proposed project. Renowned Cola, Inc.''s 2005 annual report explains that Renowned Cola''s investments are expected to generate cash returns that exceed its "long-term cost of capital," which Renowned Cola estimated to be approximately 10% at year-end 2005. Renowned Cola has three main lines of business, soft drinks, notably Dr. Cola; snack foods, such as Fritos; and restaurants. Restaurant investments include NPC, which has a beta of 0.80 and a debt-to-firm value ratio is 0.31. Renowned Cola did not report costs of capital separately for these three businesses.
Below, we have available year-end data for 2005 provided by Renowned Cola.
• Renowned Cola’s Items Values (M = millions)
• Cash and marketable securities $1,498M (market value assumed)
• Short-term debt $706M
• Long-term debt $8,509M ($8,747M market value)
• Common shares outstanding 788M
• Year-end share price $55.875
• Income tax rate 34%
• Renowned Cola''s beta 1.0
• Long-term borrowing rate 6.75%
• Short-term riskless rate 5.13%
• Intermediate-term riskless rate 5.50%
• Long-term riskless rate 6.00%
• Short-term market risk premium 8.40%
• Intermediate-term market risk premium 7.40%
• Long-term market risk premium 7.00%
• Given the above information, answer the below questions.
Questions:
1. Calculate the market value of Renowned Cola''s debt at year-end 2005. What is the book
value of debt? Why do usually use market or book values for debt? Explain. (4 marks)

2. To the nearest million, calculate the market value of Renowned Cola''s stockholders'' equity at year-end 2005. (3 marks)

3. Renowned Cola subtracts the value of its short-term debt from its total debt when calculating its "net debt ratio." Renowned Cola believes that the market values for its traded debt are not accurate because the bonds trade infrequently. Given this belief and their treatment of short-term debt, compute Renowned Cola''s net debt ratio using book values for debt and market value for equity. (5 marks)
4. Compute Leverage keeping the short-term debt as part of total debt. Using the CAPM compute re for short-term, medium-term, and long-term investments. Compute WACC for short-term, medium-term, and long-term investments. Suppose you were considering a long-term capital investment project, which WACC would you use and why? You can assume that the asset''s risk profile for the project mirrors Renowned Cola''s overall risk profile. (6 marks)

5. Should Renowned Cola use its overall cost of capital to evaluate its restaurant capital
investments? Under what circumstances would it be correct to do so? (4 marks)
Posted Date: 9/22/2013 2:42:37 AM | Location : Fiji







Related Discussions:- Wacc, Assignment Help, Ask Question on Wacc, Get Answer, Expert's Help, Wacc Discussions

Write discussion on Wacc
Your posts are moderated
Related Questions
I have been given 3 different types of projects. They state the IRR and how much the project will add. The question goes on to give a WACC with break points. The question wants

A minimum level of sales-oriented activities that must be meet up by a salesperson in the given time period. An activity quota may need a salesperson to create a certain number of

Question : (a) Compare the financial system of the Mauritius and USA. Give differences between the two systems. (b) One of the facilities given by the financial system is

Ask q• Effect of incorrect recognition of revenue on financial reports of IFRS15

A tax rate of 20% has been introduced in the Frog Islands Republic. The value of Sun corporation is now 100.000€. Bright Star Co. debt has no changed. The required rate of return t

3. Your firm has debt worth $200,000, with a yield of 9%, and equity worth $300,000. It is growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of

In January 2009 you bought a German stock portfolio for 6,000,000 Euros and sold it in December 2009 for 7,000,000 Euros.  Assume that over the same period the dollar's exchange ra

Baobab rolling mills owns a lathe machine which was purchased 10years ago at sh. 75 million. The machine had an expected life of 15 yrs at the time it was purchased, and management

Your company is considering using the payback period for capital-budgeting. Discuss the advantages and disadvantages of this technique. Your company is considering the constructio

Q. How could phoenix activity be addressed? A range of actions have been suggested to mitigate phoenix activity. These suggested actions were selected on the basis of: - pr