Papa John's Cost of Capital

* Interest rate had a 125bp spread over the current yield on 10-year US Treasury bonds (=4.25%).

We take Yields to Maturity of U.S.10 Year Treasury Note as the risk-free rate (rf). Long-term government bonds are the least risky among all financial assets. They are issued by the government so they have no default risk. Also, long-term bonds match the duration of Boston Beer’s cash flow better than short-term or medium-term bonds do. Therefore, we use the rate as our risk-free rate, which is 2.17% as of

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

Given that the cost of equity is 9.4% and the cost of debt is 12.2%, Star’s cost of capital can be calculated as 9.14% (Appendix B). The company was also considering raising the cost of debt to the industry average of 19%. At this cost of debt, Star Company would have a lower cost of capital of 8.24% (Appendix B) because interest on debt capital is deductible whereas dividend payments on equity capital are not.

As a deep-discount brokerage, Ameritrade planned to improve its competitive position by price cutting, technology enhancements, and increased advertising in mid-1997. Before initiating the plan, Ameritrade needed know whether the investment returned more than it cost. We were hired to estimate the cost of capital correctly. The key question is to find suitable comparable firms to estimate Ameritrade’s asset beta, since it was a recently-listed firm. We thought discount brokerage companies were best due to same revenue resources. Proper risk-free rate and market risk premium should also be chosen carefully, and we used 30-year bonds YTM and the annual return difference

The cost of equity was found using CAPM, with the given market risk premium of 5%, a beta of .88, and risk-free rate of 4.03%. The beta was found by running a regression of Southwest’s percent change in stock price versus the S&P 500’s percent change in stock price for two years (June 28, 2000 to June 28, 2002). The risk-free rate was the return on a ten-year treasury note issued on June 28, 2002, according to the U.S. Treasury’s website. The tax rate of 39% was used to account for tax savings from leverage. In order to calculate the firm’s leverage, the market value of equity was found from the price per share on July 24, 2002 (Yahoo Finance) and the shares outstanding on the balance sheet of the July 10-Q report, as shown in Exhibit X. The debt value was approximated at the book value since data could not be found regarding its market value. This analysis resulted in a debt weight of 11.74% and equity weight of 88.26%. The final approximation for the weighted average cost of capital was 8.64%.

Also in exhibit 3, the average annual return of the 10-year Treasury bond during the same time period is 5.28%. Therefore, the spread between the average market return and the risk-free rate, or the equity market risk premium is 6.37%.

The regression that we performed in excel for both stocks yielded a beta of .73576 for Reynolds, and a beta of 1.4198 for Hasbro. In question 2 we learned that although Reynolds stock was riskier independently, adding it to the portfolio made it more diversified compared to adding Hasbro, due to the fact that it was less correlated to the market portfolio. Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Therefore, since the beta of Reynolds is lower than Hasbro, our beta calculations align with the fact that Reynolds stock makes the overall portfolio less risky. This finding is also intuitive when considering the nature of the companies; Reynolds is a Tobacco company meaning that is should be less sensitive to changes in market conditions than a toy company like Hasbro.

The mixture of debt-equity mix is important so as to maximize the stock price of the Costco. However, it will be significant to consider the Weighted Average Cost of Capital (WACC) as well so that it can evaluate the company targeted capital structure. Cost of capital (OC) may be used by the companies as for long term decision making, so industries that faced to take the important of Cost of capital seriously may not make the right choice by choosing the right project(Gitman’s, ).

As Market risk premium I take the “Spread between S& P 500 Composite Returns and Long-Term U.S. Government Bond Returns 1926-1987” from Exhibit 5 as appropriate value.

Target Corporation is having a very stable financial policy and dividend policy. From the historical financial data, Target had debt $11,044M, $11,202M, $10,599M, $17,471M, and $19,882M in the year of 2005,2006,2007,2008, and 2009 respectively. The long-term debt/equity ratio rises from 69.34% to 108%.

We use the equation ri=(Pt-Pt-1+Dt)/Pt-1 to calculate the monthly return of stock of Charles Schwab Corp, Quick & Reilly Group and Waterhouse Investor Srvcs. Then we have two methods to calculate the Beta of Equity for each company.

A common practice to determine the firm’s beta is to draw from historical data from published sources or compare numbers to competitors. In this case, Heinz can compare to Kraft, Campbell Soup and Del Monte and use professional judgement in determining the stock’s sensitivity to the market. A stock’s beta can be determined using a formula as well.

By leveraging their company, California Pizza Kitchen adds value to their Total Market Value of Capital. They also increase their share price. It should be considered that as they increase their debt to equity ratio, they also increase their risk of default.

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.