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CALCULATING 3M’s COST OF CAPITAL
In this chapter, we described how to estimate a company’s WACC, which is the weighted average of its costs of debt,
3. Next, we need to calculate MMM’s cost of debt. We can use different approaches to estimate it. One approach is to take the company’s interest expense and divide it by total debt (which is the sum of short-term debt and long-term debt). This approach only works if the historical cost of debt equals the yield to maturity in today’s market (i.e., if MMM’s outstanding bonds are trading at close to par). This approach may produce misleading estimates in years in which MMM issues a significant amount of new debt. For example, if a company issues a great deal of debt at the end of the year, the full amount of debt will appear on the year-end balance sheet, yet we still may not see a sharp increase in annual interest expense because the debt was outstanding for only a small portion of the entire year. When this situation occurs, the estimated cost of debt will likely understate the true cost of debt. Another approach is to try to find this number in the notes to the company’s annual report by accessing the company’s home page and its Investor Relations section. Alternatively, you can go to other external sources, such as bondsonline.com, for corporate bond spreads, which can be used to find estimates of the cost of debt. Remember that you need the after-tax cost of debt to calculate a firm’s WACC, so you will need MMM’s tax rate (which has averaged around 30% in recent years). What is your estimate of MMM’s after-tax cost of debt?
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Fundamentals of Financial Management (MindTap Course List)
- Please describe a working capital management for 2 companies. 1. How their financial figure will be calculated. 2. Explain their performance. 3. Examine both of the companies based on risk factors; the upside and the dowside. 4. How is the justification should be dne based on their data and ratio. 5. Conclusion on the analysis.arrow_forwardfind the weighted average cost of capital for Jack in the Box Inc. (JACK). How is the WACC is calculated? Explain the WACC in the context of a hurdle rate, return on invested capital (ROIC), an optimal capital structure, and an optimal capital budget.arrow_forwardWhat is the weighted average cost of capital (WACC)? The cost of all of the capital for a project or company The cost of all of the equity for a project or company The cost of all of the debt for a project or company The cost of all of the venture capital for a project or companyarrow_forward
- what comment can be made on this or what can be added to it? The weighted average cost of capital is a calculation that can be done by a business to determine how much it will cost to borrow money to generate capital (WACC, n.d.). The result of this calculation will help business determine if financing a project is an investment that will yield positive returns (WACC, n.d.). The WACC takes into account the cost of equity and the cost of debt to figure out whether an investment is worth taking on (WACC, n.d.).arrow_forwardA company hired you as a consultant to help estimate its cost of capital. You have obtained the following data: D0 = $2.45; P0 = $28.96; and g = 4.06% (constant). What is the cost of equity from retained earnings? Do not round your intermediate calculations. Express your answer as a percent rounded to two decimal places. (For example, 4.567% should be entered as 4.57)arrow_forwardshortly explain all the capital structure theories and compare them with your own words (no copy paste from somewhere. Use your own book as reference.) Then randomly choose three companies enlisted in Borsa İstanbul and analyze their balance sheet. Write your comments about their capital structure and analyze with regard to risk and profitability. FINANCIAL MANAGEMENT II COURSE QUESTİONarrow_forward
- Please answer all. From a company we get the following:Capital employed 20,000,000 dollarDebt / equity ratio = 3Total income 40,000,000 dollarTotal profit 4,000,000 dollarInterest costs 1,500,000 dollarNet profit 2,500,000 dollara. Calculate the return on capital employed (Rsyss)b. Calculate the return on equity (Re)c. Show the relationship between profit margin and capital turnover rate and return on capital employedd. Demonstrate the relationship between the return on equity (Re) and the return on employed capital (Rsyss) with the help of the financial exchange!arrow_forwardCalculate the Weighted Average Cost of Capital (WACC) for McCormick and Company using the formula WACC = (WD x RD x (1-T)) + (WS x Rs) Note that -- Rs = the cost of equity Rd = the cost of debt T = the tax rate WD = Value of debt / (Value of debt plus value of equity) WS = Value of equity / (Value of debt plus value of equity) **Note that the weight of debt plus the weight of equity must total to 100%, as there are only two components in the capital structure.** In order to estimate the weights of debt and equity in the total capital structure, the CFO suggests using the book value of debt and the market value of equity. To determine the book value of debt, use data from the year end November 2019 McCormick 10-K. Look on the Balance sheet and add the following -- Short term borrowings, Current portion of long term debt, and Long term debt. To determine the market value of equity, use the following data: On March 17, 2020 the market value of equity (or "Market Cap")…arrow_forwardWhat is WACC (select all that are true)? Group of answer choices Rd (1-Tc) * D/V + Re * E/V Weighted Average Cost of Capital For a firm overall, it is based on the riskiness of the firm's assets While it is generally estimated by looking at the right-hand-side of the balance sheet, it is largely driven by the left-hand-side (i.e., assets) It is the amount that equity holders demand for an investment in a firm It is the amount that debt holders demand for a loan made to the firmarrow_forward
- The market values and after-tax costs of various sources of capital used by Ridge Tool are shown in the following table. Source of capital Market value Individual cost Long-term debt $700,000 5.3% Preferred stock 50,000 12.0 Common stock equity 650,000 16.0 a. Calculate the firm’s WACC. b. Explain how the firm can use this cost in the investment decision-making process. Please show your work.arrow_forwardThe formula to calculate EVA is Net operating profit - (invested capital × weighted average cost of capital). Contribution margin - (average capital assets × internal rate of return). Contribution margin – (invested capital × weighted average cost of capital). Net operating profit - (average capital assets × internal rate of return). O O O Oarrow_forwardUse the information provided below to answer the following questions: 4.1 Calculate the weighted average cost of capital (calculations expressed to two decimal places, where applicable). (16 marks) 4.2 Calculate the cost of equity using the Gordon Growth Model (expressed to two decimal places). (4 marks) INFORMATION Capri Limited intends raising finance for a proposed new project. The financial manager has provided the following information to determine the present cost of capital to the company: The capital structure consists of the following: ■ 2 million ordinary shares issued at R2 each but currently trading at R3 each. The company’s beta coefficient is 1.4. The risk-free rate is 9%. The return on the market is 17%. ■ 1 million 12%, R2 preference shares with a market value of R3 per share. ■ R1 000 000 20% Bank loan, due in January 2026. Additional information ■ The Capital Asset Pricing Model is used to determine the cost of equity. ■ A dividend growth of 10% per annum on ordinary…arrow_forward
- Fundamentals of Financial Management (MindTap Cou...FinanceISBN:9781285867977Author:Eugene F. Brigham, Joel F. HoustonPublisher:Cengage Learning