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.
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
Question: i) Compare and contrast the various types of fixed income securities. ii) ‘A new issue of callable bonds will generally carry a higher interest rate

Introduction to the company and its business 2. From the information given in the financial statements, calculate the company’s operating and financial leverage. 3. Obtain the info

You are planning to open a homeless shelter called Helping Hands Mission Inc. in fiscal year (FY) 2011. You expect to have 60 beds and to operate at full capacity throughout the ye

1)   Select an organization that you are familiar with and evaluate the steps needed to  transform  the business plans into Balance Score Cards & Key Performance Indicators 2)

What is the industry average price-earnings ratio? What is the price-earnings ratio for Ragan, Inc.? Is this the relationship you would expect between the two ratios?

what is the agency relationship between shareholders and auditore

The approved budget for 1997, reduced government spending in housing and urban development, health and human service, and education. Ignoring any other modifications, how would Cl

What will be impact on the operating leverage of a firm, if it proceeds for additional borrowings?

The Vodafone Corporation arranged a one-year, $1.5 million loan to fund a foreign project. The loan was denominated in Euros and carried a 10% nominal rate. The exchange rate at