Castillo Mini Case 2 Essay

1083 Words Jan 28th, 2013 5 Pages
The Castillo Products Company was started in 2008. The company manufactures components for personal digital assistant (PDA) products and for other handheld electronic products. A difficult operating year, 2009, was followed by a profitable 2010. The founders (Cindy and Rob Castillo) are interested in estimating their cost of financial capital because they are expecting to secure additional external financing to support planned growth.
Short-term bank loans are available at an 8 percent interest rate. Cindy and Rob believe that the cost of obtaining long-term debt and equity capital will be somewhat higher. The real interest rate is estimated to be 2 percent, and a long-run inflation premium is estimated at 3 percent. The interest rate on
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E. Cindy and Rob estimate that the market value of the common equity in the venture is $900,000 at the end of 2010. The market values of interest-bearing debt are judged to be the same as the recorded book values at the end of 2010. Estimate the market value-based weighted average cost of capital for Castillo Products.
F. Would you recommend to Cindy and Rob that they use the book value–based WACC estimate or the market value–based WACC estimate for planning purposes? Why?

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SOLUTION:

(a) 2009 net profit margin = -65,000/900,000 = -.0722 = -7.22% 2010 net profit margin = 75,000/1,500,000 = .500 = 5.00%

2009 total-sales-to-total-assets = 900,000/1,000,000 = .9000 times 2010 total-sales-to-total-assets = 1,500,000/1,200,000 = 1.2500 times

2009 equity multiplier = 1,000,000/(150,000 + 200,000 + 80,000) = 1,00,000/430,000 = 2.3256 times 2010 equity multiplier = 1,200,000/(150,000 + 200,000 + 120,000) = 1,200,000/470,000 = 2.5532 times

2009 return on equity = -65,000/430,000 = -.1522 = -15.22% 2010 return on equity = 75,000/470,000 = .1596 = 15.96%

Castillo Products improved from an operating loss in 2009 to profitability in 2010. The net profit margin went from negative to positive. The asset turnover (total-sales-to-total-assets)

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