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QUESTION

BSA 554 Week 10 Final Major WACC Project

The WACC instructions are the following from the syllabus:

·         Obtained the company’s 10-K report containing key information, such as the overall corporate tax rate for use in the pre- and post-tax debt costs.

·         Determined the company’s Beta coefficient from publicly available information and stock data on the company.

·         Determined an appropriate risk-free rate available from U.S. Treasury data posted each day on a website.

·         Do "NOT" use the interest rates provided in the instruction assignments for the risk-free rate and for the market risk premium.  You will have to find an appropriate risk-free rate from the US Federal Reserve Current Interest Rates link as http://www.federalreserve.gov/releases/h15/current/default.htm

·         Do "NOT" use the market risk premium provided in the instructions document, but rather determine the market return (RM) for the appropriate benchmark for fiscal 2014.  You may want to find the return of the S&P 500 US Equity Index for the SPY or for the ^GSPC.  You may also want to investigate the Sector return for fiscal 2014 for your company within the S&P 500 US Index Equity benchmark. 

·         http://www.sectorspdr.com/sectorspdr/

·         Please show how the risk-free rate and how the return of the market rates were determined in the paper.

·         Begun work in determining the overall stock market rate of return, particularly by reviewing the work done by Professors Fama and French.

·         Determined the current market required rate of return on corporate bonds for a similar company as the one selected.

·         Determined if the company has any preferred stock.

·         Based on the existing level of debt, preferred stock, and common equity in the company, each student should be able to calculate or determine the company’s current target ratio as decided by the chief financial officer (CFO) and other top-level corporate officials.

·         Completed the analysis of their selected company’s target cost of capital (WACC), based on the existing level of debt, preferred stock, and common equity in the capitalization structure.

·         Determined the appropriate risk-free rate of return, the Beta, the overall market rate of return, dividend payouts and historical payouts to determine the dividend growth rate, the corporate tax rate, and the current corporate bond rate for yield to maturity bonds.

·         Started calculating alternative WACCs as a function of varying amounts of debt in the capitalization structure:  Please review the Chapter 15 Problem 11.

·         Completed the final WACC calculations for varying amounts of debt in the capitalization structure

·         Graphed the U-shaped curve in Excel, indicating where the maximum (lowest) WACC lies, in terms of the amount of debt that should be used in the structure using Excel to graph, as well as the current target capitalization structure used by the company should be shown

 Please follow the GUIDELINES provided that include the steps involved in the construction of the paper.

WACC Project Check-list:

1.       Step 1.  Determine the firm’s rd from the 10-K report in the Note to the Long-term Debt, where rd = ∑(wdi*rdi), where wdi = the weight of debt for each bond and rdi is the coupon rate for each bond.  Please regard equation 6.6 on page 247 for a review of the methodology.

2.       Step 2.  Construct the capital structure of the firm to find the wd and we components of the WACC.  Note that the dollar amount of long-term debt and the dollar amount of total equity should be utilized.  Preferred equity dollar amount should be included in the calculation if the firm still has preferred equity outstanding.

3.       Step 3.  Find the firm’s beta.

4.       Step 4.  Determine the firm’s tax rate from the 10-K information.  Please make sure to include the page number where you determined the firm’s tax rate in the 10-K report from the previous fiscal year.

5.       Step 5.  Find either the 1-year Treasury bill rate or the 10-year Treasury note rate at the close of the firm’s fiscal year.  If the risk-free rate is provided by the firm in the 10-K, please utilize this percentage. Full credit will not be earned if the 4% rfr in the givens in the instructions is utilized.  

6.       Step 6.  Find an appropriate rm percentage for the previous fiscal year.  Full credit will not be earned if the 8% rpm given in the instructions is utilized.  

7.       Step 7.  Construct the current CAPM rs for the firm.  Please review page 258, equation 6.14.

8.       Step 8.  Construct the current WACC for the firm.  Please review page 375, equation 9.2.  Note that you do not have to utilize the short-term debt portion in the equation.

9.       Step 9.  Calculate the beta unlevered.  Please review page 611, equation 15-10.

10.   Step 10.  Calculate the new beta levered at plus or minus 5% or 10% intervals of wd in the firm’s capital structure.  Please review page 611, equation 15.9a.

11.   Step 11.  Determine the new rs CAPMs at each differing capital structure utilizing the new levered betas.

12.   Step 12.  Make sure to adjust the rd by plus or minus the percentage of wd’s change, so that a leverage increase of 5% should result in a new rd of (rd*1.05) and a leverage decrease of 5% should result in a new rd of (rd*0.95).  Please refer to page 610 figure 15-5.

13.   Step 13.  Please review the week-10 announcement that includes information on problems 15-9, 15-10, and 15-11 on pages 622 and 623.

14.   Step 14.  Replicate rows 1 to 6 in figure 15-5 to determine the capital structure where WACC is minimized.

15.   Step 15.  Graph the WACCs at the different capital structures of the firm as stated in the instructions.    

       Please follow and label each step in the construction process of the project.  Remember that you should be examining a US Headquartered public-traded for-profit corporation.

Consider the following simple rules of observation to help determine the final results:

·         If the Beta coefficient and the required rate of return on common equity is not increasing constantly as the amount of debt in the structure moves from 0% to increasing levels of debt, something is wrong.

·         If the cost of debt does not fall and then begin to increase as the risks of bankruptcy increase, something is wrong.

·         If the WACC curve does not display some type of U-shaped form (Note: You may have to make the vertical percentage cost scale have very small increments to show this.), something is wrong.

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