Weighted Average Cost of Capital and Yeats

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Extra Credit Assignment:
Yeats Valves and Controls Inc.

Completed as a Group with the Following Individuals: (in alphabetical order by last name)

Adetunji Adeniyi Tung F. Cheng Gregory Chiu Rashmin Patel WenHao Zhang

Course Title: Accounting and Finance Course No./Section: MG6093 Instructor: Frank X. Apicella November 28, 2012

Yeats Valves Question

The following are questions which should focus the groups on important aspects of the Yeats Valves case. Note the actual case name is Yeats Valves and Controls, Inc. The case number is UV0094. There is also a spreadsheet - that number is UV0184.

As mentioned - the corresponding case is TSE
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It is the minimum return a company needs to earn in order to satisfy its investor base (as weighted for the amount of debt vs. equity in the target/capital structure), which is what the company must pay investors to raise new financing to support new projects or ventures. WACC is particularly useful here because Yeats has no debt, thus, it is an equity financed company. In the case of Yeats, the company must have capital to continue to develop and market its new Widening Gyre Program.

The formula for WACC = Re (E/V) + Rd (D/V)(1-t)
However, because Yeats does not have debt, the second half of this formula, Rd(D/V)(1-t) is not necessary. Being that Yeats has zero debt, the value of its equity is in full, which represents its Enterprise Value. Tax (t) is determined in the case as 40% or .40 (p. 5).

We must then calculate the CAPM for the cost of equity (see Excel sheet for details):
Re = Rf + Beta (Rm-Rf)

Re = Required Return on Equity
Rf = Risk Free Rate = 5.98 (p. 16)
Beta = Measure of Risk relative to the general market (volatility) = 1.5 (p. 5)
Rm-Rf = Equity Market Risk Premium (EMRP) = 5.5 (p. 16)
Rm = Market Risk
Rf = Risk Free Assets (U.S. treasury security)
With Beta at 1, the stock price changes in precise tandem with the market, but with Yeat’s beta at 1.5, it is more risky than a group of peer stocks.
Re = Rf + Beta (Rm-Rf)
Re = 5.98 + 1.5 x 5.5
Re = 14.23%, the cost of equity at for Yeats

Then calculate

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