North West Company Case

Barb Williams and Rick Thomas, while attending an executive education course at a well-known business school, came across a case which involved calculating the cost of capital for Telus Corporation (Telus). Basic data such as the Balance Sheet, Income Statement, Data on Telus’ Common Stock, Market Index, and the Average Annual Returns in North American Capital Markets were provided. In order to calculate Telus’ cost of capital we need to calculate the company’s Cost of Equity, Cost of Debt, and Tax Rate along with their weighted cost and then apply these to the Weighted

Based on the suggestion that the focus should be on market values, compute the weights of debt, preferred stock, and common stock.

Given these approximations, the CAPM model would total the risk-free rate and the market risk premium times beta to arrive at a cost of equity of 9.68%, which reflects the investors’ expected return from investing in shares of the company.

Laurier Company had purchases Western company; they had agreed upon to terminate twenty employees. As part of the investments, they had agreed to give a severance package to former Western’s employees who were terminated in the past year would receive an equivalent severance package as Laurier's former employees. Bill Smith worked at Western Company for ten years who were one of the twenty that were laid off. Bill complain that his five weeks’ severance package was less than that offered to Laurier’s employees. By determine if Bill’s statement was true, a statistician was brought in to settle the dispute. The analyst determined the severance by the number of weeks of severance pay on the number of years with the company. The analyst will collect

Utilizing the fundamental concepts of the Capital Asset Pricing Model (CAPM), the expected return for Wal-Mart stock is 7.01% [E(R)]. This is a result of a risk-free rate (Rf) of 3.68%, which was the provided 10-year government bond yield to use as a proxy for the risk-free rate. The beta (β ) of Wal-Mart was 0.66 according to the provided Bloomberg beta estimate. Additional data was provided on the U.S. market risk premium [E(RM) – Rf] of 5.05%. In following the general concepts of CAPM, there are some general assumptions: no transaction costs, all assets are publicly traded,

A few weeks earlier, John M. Case, board chairman, president, and sole owner of the

Using CAPM to provide the calculation for the equity, this presents both positive and negative effects.

CAPM results can be compared to the best expected rate of return that investor can possibly earn in other investments with similar risks, which is the cost of capital. Under the CAPM, the market portfolio is a well-diversified, efficient portfolio representing the non-diversifiable risk in the economy. Therefore, investments have similar risk if they have the same sensitivity to market risk, as measured by their beta with the market portfolio.

Please refer to Appendix 2 for other considerations for cost of equity calculations. Most firms use the Capital Asset Pricing Model (CAPM) to determine the cost of equity. The components that make up the CAPM include: the risk free rate, the beta of the security, and the expected market return of the stock. These values are all based on forward-looking data. The model dictates that shareholders require a return equal to the return from a risk-free investment plus an equity risk premium for bearing extra risk. Refer to Appendix 1 for a full breakdown of the CAPM formula.

Weights of Debt and equity are 8.3 and 91.7%. Now, plugging all the values in, we can derive company’s Weighted Average Cost of Capital.

of outstanding shares) + (short-term debt + long-term debt + capitalized leases + preferred stock - cash on hand)

Figure 9 (page 27 – 29) shows the security market line input data and graph. The security market line equation is used on page 27 to calculate the required rate of return on each investment alternative. Each investment’s expected return is compared to the required return calculated by the SML. Based on whether or not the expected return is higher or lower than the required return will determine if the investment is overvalued, fairly valued, or undervalued. For example, page 27 shows that Gold is overvalued and Food is undervalued.

Each firm has an optimal capital structure, defined as that mix of debt, preferred, and common equity that causes its stock price to be maximized. A value-maximizing firm will determine its optimal capital structure, use it as a target, and then raise new capital in a manner designed to keep the actual capital structure on target over time. The target proportions of debt, preferred stock, and common equity, along with the costs of those components, are used to calculate the firm’s weighted average cost of capital, WACC.

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We use the Capital Asset Pricing Model (CAPM) to determine the cost of equity. As