Shane Corley Brittany Millermon Coba B 1. What is the purpose of using market values is cost of capital calculations?

The purpose of using market values is to offer a more accurate estimate as to the current value of capital for the company because a book value is generally not as recent or up to date; secondly a market value is the only way to estimate a value on a company which is not publicly traded. In this instance a comparison value will be used form a company like the one which is not public. 2. What is COBAs cost of equity using the dividend growth model (see COBA A)? Using the SML? Explain the difference between these numbers. (Assume that the risk-free rate of interest is 3% and the firms beta is 1.41.) Dividend Growth model=,Ke= D(1+G)/P+G, Ke= ((.91)*(1+11.91%)/20)+11.91%=17.002%, SML= Rf+(Rm-Rf)*B,= .03+(0.115 -.03)*1.41=14.985% The reason that these numbers differ is because the SML is accounting for the market value and the Beta, while the dividend growth does not. 3. What is COBAs weighted average cost of capital using the information in question 2?
kwacc = wd * kd * (1 - Tc) + (wps * kcs) + (wcs * kcs)= .09*((1-.35)*(21750/46750))+

((.17*

(25000/46750))=11.81%.
4. What is the beta for each of COBAs divisions, if, in a pure-play sense, division A has a market value of debt of $11.2 million and division B has a market value of debt of $14.5 million and the firms total market value of equity is invested equally in each division. (The unlevered beta is 1.0) Division A = 1*(1+(1-.35)*(11,200,000/20,000,000)=1.364 Division B= 1*(1+(1-.35)*(14,500,000/20,000,000)= 1.471 5. Answer item 4 from the case.

The cost of capital calculation only affects capital budgeting in the sense of where the money comes from, for example in our equation above every dollar made 11.81 percent must be returned to the shareholders. The cost of capital calculation simply refers to where the funds are coming from to fund a project not how much is used to fund the project. 6. If the company had only three capital expenditure projects up for consideration prior to Sims work and the respective IRRs on the three were 16.3%, 11.7%, and 11.4%; how wouldSims calculations affect the disposition of these projects? Based on Sims caluclations we would only accept the project with the IRR of 16.3 because it meets and surpasses our required rate of 11.81 while the other two projects do not. 7. What capital assumption is IMPLICIT in the task assigned to Sims? We believe that one implicit assumption is that the risk free rate of investment is 3 percent. It is only an assumption we have no information to back this percentage. Also is our Beta value of 1.41. Sims does not determine the beta herself. 8. What is the rationale for preference of the externally influenced SML in the cost of capital calculation? The reason the SML value is prefereed over the growth rate model because it references the market value of a firm giving a more accurate number then just a book vlaue, if just a book value is used in the case of Apple for example the true value would be far off as the stock value and market value of Apple fluctuate rapidly. 9. In general, how have interest rates on long-term debt behaved over the past 5 yuears? That is, what are the high and low levels of such rates over the period?

In general it appears the interst rates have remained fairly steady between 0 and 5 percent. 10. Consider your answer to questions 8. What is the implication for the cost of capital calculation? The implication is that we have taken the real market value of the frim into consideration and therefore should have a more accurate number. In our example it gave us a lower value which could be considered more conservative and therefore a safer investment. 11. Is the weighted average cost of capital the only correct discount rate to use in capital investment decisions? No there is no one correct discount rate to use, it is up to the preference of the frim and the investors as stated in class discussion. 12. Comment upon the rationale for historical data and trends being reflected in the return on the market calculation used in the SML equation. Trends and historical data help us determine our best estimation for a risk free ratea s well as affect our overall market values. The historical data will helps us determine our interest rates to use for determineing a long term investment. Many of our caluclations are merly estimates based on approximations of our data.

How the fed increases interest rates.. higher interest, more expensive borrowing and less debt financing. Higher default risk. Higher beta.