Reference no: EM132412321
CASE 1. COST OF CAPITAL FOR SWAN MOTORS You have recently been hired by Swan Motors, Inc. (SMI), in its relatively new treasury management department. SMI was founded eight years ago by Joe Swan. Joe found a method to manufacture a cheaper battery that will hold a larger charge, giving a car powered by the battery a range of 700 miles before requiring a charge. The cars manufactured by SMI are midsized and carry a price that allows the company to compete with other mainstream auto manufacturers. The company is privately owned by Joe and his family, and it had sales of $97 million last year.
SMI primarily sells to customers who buy the cars online, although it does have a limited number of company-owned dealerships. The customer selects any customization and makes a deposit of 20 percent of the purchase price. After the order is taken, the car is made to order, typically within 45 days. SMI's growth to date has come from its profits. When the company had sufficient capital, it would expand production. Relatively little formal analysis has been used in its capital budgeting process. Joe has just read about capital budgeting techniques and has come to you for help. For starters, the company has never attempted to determine its cost of capital, and Joe would like you to perform the analysis. Because the company is privately owned, it is difficult to determine the cost of equity for the company. Joe wants you to use the pure play approach to estimate the cost of capital for SMI, and he has chosen Tesla Motors as a representative company. The following questions will lead you through the steps to calculate this estimate.
Suppose you find the following information about Tesla Motors.
Market price = $254.61
Market capitalization = $40.96 billion
Book value per share = $17.89
Shares outstanding = 160.87 million
Most recent dividend = $0
Beta = 1.19 3-month Treasury bill rate = .46%
Use the information on the bond that has a maturity of 2021 below. Book value of the bond: $1,200 million
Coupon Maturity Price Yield
TSLA-01 1.50 06/01/2018 190.851 -41.209
TSLA-02 0.250 03/01/2019 98.20 1.121
TSLA-03 1.25 03/01/2021 94.080 2.789
Case 1: QUESTIONS
1. Find the cost of equity for TSLA.
2. Find the cost of debt for TSLA.
3. Calculate the weighted average cost of capital for TSLA. Calculate this using book value weights and market value weights, assuming TSLA has a 21 percent tax rate. Which number is more relevant?
4. You used TSLA as a pure play company (i.e., a company that focuses only on a particular product or activity) to estimate the cost of capital for SMI. Are there any potential problems with this approach in this situation?