Description
Purpose of Assignment
Students should understand the mechanics in calculating a company's weighted average cost of capital using the capital asset pricing model (CAPM) and its use in making financial investments.
Assignment Steps
Resources: Tutorial help on Excel® and Word functions can be found on the Microsoft® Office website. There are also additional tutorials via the web that offer support for office products.
Scenario: You work for an investment banking firm and have been asked by management of Vestor Corporation (not real), a software development company, to calculate its weighted average cost of capital, to use in evaluating a new company investment. The firm is considering a new investment in a warehousing facility, which it believes will generate an internal rate of return of 11.5%. The market value of Vestor's capital structure is as follows:
Source of Capital | Market Value |
Bonds | $10,000,000 |
Preferred Stock | $2,000,000 |
Common Stock | $8,000,000 |
To finance the investment, Vestor has issued 20 year bonds with a $1,000 par value, 6% coupon rate and at a market price of $950. Preferred stock paying a $2.50 annual dividend was sold for $25 per share. Common stock of Vestor is currently selling for $50 per share and has a Beta of 1.2. The firm's tax rate is 34%. The expected market return of the S&P 500 is 13% and the 10-Year Treasury note is currently yielding 3.5%.
Determine what discount rate (WACC) Vestor should use to evaluate the warehousing facility project.
Assess whether Vestor should make the warehouse investment.
Prepare your analysis in a minimum of 700 words in Microsoft® Word.
Explanation & Answer
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Running head: WEIGHTED AVERAGE COST OF CAPITAL
Weighted Average Cost of Capital
Name
Course Title
Instructor
Date
WEIGHTED AVERAGE COST OF CAPITAL
1
Weighted Average Cost of Capital
Introduction
According to Hitchner (2010), the weighted average cost of capital (WACC) is the
blended cost of the company’s capital structure components, each weighted by the market value
of that capital component. As such, the use of a WACC method to determine value can be
suitable for evaluating the financial result of potential projects. In this paper, we will be
determining Vestor Corporation’s weighted average cost of capital using the capital asset pricing
model (CAPM). The corporation’s management is looking to evaluate a new investment in a
warehousing facility.
Capital Asset Pricing Model
Often, the financial manager encounters an investment decision, where he or she must
consider how the risk of the investment may influence the firm's overall corporate risk and that
of its shareholders (Chang, 2010). Derived from the capital markets, the CAPM strives to
provide a measure of mark...
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