   Chapter 10, Problem 1TCL Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

Solutions

Chapter
Section Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

CALCULATING 3M’s COST OF CAPITALIn this chapter, we described how to estimate a company’s WACC, which is the weighted average of its costs of debt, preferred stock, and common equity. Most of the data we need to do this can be found from various data sources on the Internet. Here we walk through the steps used to calculate Minnesota Mining & Manufacturing’s (MMM) WACC.1. As a first step, we need to estimate what percentage of MMM’s capital comes from debt, preferred stock, and common equity. This information can be found on the firm’s latest annual balance sheet. (As of year end 2013, MMM had no preferred stock.) Total debt includes all interest-bearing debt and is the sum of short-term debt and long-term debt. a. Recall that the weights used in the WACC are based on the company’s target capital structure. If we assume that the company wants to maintain the same mix of capital that it currently has on its balance sheet, what weights should you use to estimate the WACC for MMM? b. Find MMM’s market capitalization, which is the market value of its common equity. Using the sum of its short-term debt and long-term debt from the balance sheet (we assume that the market value of its debt equals its book value) and its market capitalization, recalculate the firm’s debt and common equity weights to be used in the WACC equation. These weights are approximations of market-value weights. Be sure not to include accruals in the debt calculation.

a.

Summary Introduction

To identify: Weights used to estimate the WACC for M Company.

Introduction:

Weighted Average Cost of Capital (WACC):

It refers to the average of cost of capital, which is raised from the debt, equity, and preference shares, it represents the weights assigned to the components of cost of capital.

Explanation

From www.marketwatch.com,

Book value of debt is $12.16 billion Book value of equity is$11.56 billion.

Present WACC is 8.25%.

Formula to calculate weight of equity,

Weightofequity=EquityEquity+Debt

Substitute $11.56 billion for equity and$12.16 billion.

Weightofequity=$11.56billion$11.56billion+$12.16billion=$11.56billion$23.72billion=0.49 Formula to calculate weight of debt, Weightofdebt=DebtEquity+Debt Substitute$11.56 billion for equity and $12.16 billion. Weightofdebt=$12.16billion$11.56billion+$12.16billion=$12.16billion$23

b.

Summary Introduction

To identify: Market capitalization of M Company and recalculation of WACC.

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