Executive Summary
Sue Pane the chief executive at American bakery giant Tasty Bread has interest in a major expansion into this business. There has been developed a financial analysis by the forecasting team and based on this analysis Sue Pane forecasted that Tasty Bread requires an initial investment of $250 for the expansion of the business to produce jams and jellies and as a result of this investment it will generate a return of 7.5% by coming 10 years. When making expansion into their business Tasty Bread needs funds for investments. These funds can be procured from different types of investors, equity investors and debt investors, etc. These investors while providing the funds to the firm will have an expectation of receiving a minimum return from the firm. This expected return of 7.5% by the investors depends upon the risk-appetite of the investors and also on the characteristics of the Tasty Bread. This expected return required by the investors is cost of capital for Tasty Bread. In order to evaluate expected return it is recommended for Pane to not only set a benchmark return but also estimate the cost of capital, determine the capital structure weights as well as additional considerations to estimate cost of capital at Tasty Bakery. While making investment decisions, it is recommended for Tasty Bread to choose that alternative which generates at least that much return which is expected by the investors of the firm. Otherwise, the firm will not take up that alternative. In order to maximize the value of the firm, the cost of all the different sources of the funds must be minimized (Watson, & Head, 2016). It is also proposed for the Tasty XXXXX XX use a XXXXXXXXXX of comparable firms in order to XXXXXX the XXXXXXXXXX XXXXX XXXXXXXXXX with XXXXXXXXXX WACC estimates XXX X.X% cost XX XXXXXXX XX regarded as the XXXXXXXXXXX estimate XXX Tasty XXXXX based XX XXX cost XX XXXXXXX XXXXXXXXX of the comparable XXXXX rather XXXX XXX own cost XX capital.
XXXXXXXXX & Estimating the Cost XX Capital XX Tasty XXXXX
To estimate the cost XX XXXXXXX at Tasty XXXXX there XXX XXXX made a risk analysis by the XXX XXXXXXX, a XXXXXX XX XXXXXXXXXXX XXXX, XXXXXXXXX the return XXXX XXX X comparable XXXXXX sector XXXX in the XXX XXX XXXXX XXXXXXXX such as XXXXX XXXXX, White Oak XXX XXXXXXXXX Mountain XXX it was accessed that XXX risk associated with XXX returns of XXXXX XXXXX XXX similar to XXXX he expected XXX the returns XX the proposal.
Estimate the Cost XX Debt XXX equity
Torrada estimated the XXXXXXXX return XXX equity XXX debt in XXXX firm XX XXXXXXXX the XXXXXXXX returns XXX X comparable firms. XXX following XXXXXXXXXX XXX meant to XXX the XXXXXXX in XXXXXXXXXXXXX XXXXXXXXXX the cost XX XXXX.
XXXXXXXXX 1: Good XXXX-of-debt XXXXXXXX consider XXX XXXXXXXXXX XXXX XXXXXXX of XXXX XX comparable risk.
Principle 2: XXXX cost-of-XXXX measures are XXXX concerned with XXXXXXXX XXX characteristics of the investments being evaluated XXXX XXX characteristics of the XXXXXXXX’s prevailing debt XXXXXXXXXX.
XXXXXXXXX 3: XXXX cost-of-XXXX measures XXXXX XX XXX XXXXXXXXXXX cost for debt XXXXXXX today.
Assets XX XXXXX XXX XXX XXXX financed XXXXXXX debt XXX XXXXXX, XXX returns those XXXXXXX generated XXXX divided among XXXXXX XX well as debt holders. According XX XXXXXXXXX Table X XXX return required by XXX XXXXXX XXXXXXX (X.X%) is substantially XXXXXX XXXX XXX return required XX the XXXX XXXXXXX (X.X%) since XXX XXXX for XXX equity holders is XXXXXX XX XXXXXXX XX XXX XXXX for the debt holders. XXXXXXX, debt holders XXXXXXXXXX the XXXXX XXXXX XX the returns XXXX's XXX XXXXX risk was lower XXXX equity XXXXXXX. XXX XXXXXXXX XXXXXXX XXXXXXXX XXXXXX XX XXXX XXX XXXXXX XXXXXXX XXXXX to XXX XXXXXXXX XXXXXX XX XXX XXXXXX return since XXXX holders and XXXXXX XXXXXXX combine to XXXXXX XXX overall assets returns. In XXXXXX XXXXX, the XXXX XX XXXXXXX for the XXXX XXXXXX is equal XX XXX WACC XXX XXX various XXXXX XX investors.
The assets of Sugarloaf XXXXXXXX are XXXXXXXX XXXXXXXX through equity XXXXXX XXXXX it XXX XX XXXX. XXXXXXXXXXXX, XXX cost of XXXXXX (X.2%) XXXXXXXX an estimate XX the XXXX of capital, since the equity is XXX only source XX XXXXXXX. XX XXXXXXXXXXXXXX, XXX XXXXXXXX return or XXXX of capital XXX Sugarloaf XXXXXXXX investments is XXXXXXXX using Torrada’s XXXXXXXX XX XXXXXXXXX Mountain’s XXXX XX equity, 8.X% (Michael,2014).
XXXXXXXXXXX XXX Capital Structure XXXXXXX XX XXXXX XXXXX
XX XXXXXXXXX weights to XXXX and XXXXXX, it is XXXXXXXXX to XXXXXX XXXX XXXX should reflect XXX XXXXXX investors find XXXXXXXX. XX is XXXXXXXXXX to XXX the XXXXXXX XXXXXXX structure XXXXXXX in XXXXXXXXXX the cost XX capital XXX it is XXXXXXXXXXXXX XX XXXXXX the XXXXXXX XX it XXX an XXXXXXXXXXXXX XXXXXXX structure. In order to obtain a XXXX XXX XXX XXXXXX in XXX XXXX he XXXX a weighted average XX XXXXXXXXX. The Table X shows the XXXXXXXXXXXX XX WACC estimation.
(XXXXX X) WACC estimation
XXXXXXXXX XXXXXXXX
White Oak
XXXXX XXXXX
XXXX XX XXXX (XXXXXX)
NA
5.X%
X.X%
XXXX of debt (XXXXX XXX)
XX
3.X%
X.9%
Cost of equity
X.2%
9.8%
10.7%
Percentage debt
X%
XX%
Percentage equity
XXX%
70%
Weighted average
X.0%
For White Oak the XXXX can be XXXXXXXX just XXXXXXXXXXX XXX XXXXXXX XX the required XXXXXXX because XXXXX Oak XX funded with 30% debt and 70% XXXXXX. Because XXXX payments are tax deductible XXXXXXXXX it cost White XXX only X.X% to XXXXXXX debt XXXXXXX of 5.0% with a marginal tax rate XX 34%. For XXXXX XXX the calculated cost of XXXXXXX estimate XX as follow:
XXXX (White XXX) = X.XX × X.X% + 0.XX × 9.8% = X.X%.
Similar XXXXX has been XXXX XX XXXXXXXX XXX XXXX of capital for Moose
River at X.X%: WACC (XXXXX River) = 0.XX × X.9% + X.60 × 10.X% = 8.0%.
Findings and XXXXXXXXXXXXXXX
Two XXXXXXXXX types XX XXXXXXXXX XXX XXXXXXXX for XXX XXXXXXX XX assets at XXXX XX the XXXX XXXX as equity investors and XXXX investors. In order to XXXXX XXX XXXXXXXX XXXXXX XXX the XXXXXX of each XXXX the XXXXXXXX average XXXXXXXX return XX XXXXXX and XXXX XXXXXXXXX. XXX XXXXXXXX XXXXXXXX XXX cost of capital XXXXXXXXXX XX determined through XXX method XX estimating a weighted XXXXXXX XXXX of capital (WACC) XX XXXXX XXX weighted XXXXXXX of XXX prevailing costs of debt XXX equity. It is important XX XXXXXX XXXX XXX XXXX and return XXXXXXXXXXXXXXX of the assets irrespective XX how XXX XXXXXX XX XXX assets are divided; XXXX XX the XXXXX concept XX XXX XXXX. There has XXXX maintained certain discretions XXXXX estimating XXX XXXX XX XXXXXXX. XXXXX the risk XXXXXXX linked to jams XXX jellies business is XXXXX different from the main bakery XXXXXXXX XX the Tasty Bread therefore, XXXXX XXXXX has been excluded. XXXX XX XXXXX XXXXX XX XXXXXX to suitable XXX XXXX adjusted benchmark XXXX XX X.X%. XXXXX making the investment decision XXX selection of XXXXXXXXXX firms XXX some criticism, therefore in order XX justify this XXXXXXXX WACC of Tasty XXXXX XX not included XX XXX XXXXX XXX cost XX capital XXX't XXX XXXX of funds. The opportunity XXXX of capital should be taken XXXX XXXXXXXXXXXXX than XXX XXXX of XXXXX XXXX XXXXX Tasty XXXXX's capital XXX XXXXXXXXXX. XX XXXXXX XXXXX, XXX jams and XXXXXXX XXXXXXXXXX required to be XXXX XXXX the benchmark XX jams and XXXXXXX and not the bakery benchmark; this all XXXXX XX consider where the XXXXX is going and not where XXX money XX XXXXXX.
Tasty XXXXX's jam and XXXXXXX investment XX XXXXXXXXX XX the weighted XXXXXXXX XXXXXXXXX XX XXXXX XXXXX 8.0%, XXXXX Oak X.8% XXX Sugarloaf Mountain X.2%. The XXXXXXXXXXX of XXX XXXXXXXXX increased XXX XXXXXXXXXX XXXX the XXXXXXXXXXX XXXXXX XXXX XXX the XXXXXXXXXX project was X.X% since XXXX XXXXXXXX XX XX the prevailing XXXX of XXXXXXX XXX investments XX similar risk. XXXXXXX XXX X.X% XXXX XX XXXXXXX XXXXXXXX XXX XXXXXXXX return XX 7.5%
Since the X.0% XXXX of XXXXXXX XXXXXXX XXXX XXX expected return of X.5% XXXXXXXXX it would XXX create economic value for jam and XXXXXXX investment under the XXXXXXX XXXXXXXX. It is XXXXXX for Tasty Bread to use a collection XX comparable XXXXX in order to reduce XXX estimation error XXXXXXXXXX XXXX individual WACC estimates XXX 7.0% cost of capital XX XXXXXXXX as XXX XXXXXXXXXXX XXXXXXXX for XXXXX XXXXX based XX the cost of XXXXXXX XXXXXXXXX of XXX XXXXXXXXXX XXXXX XXXXXX XXXX its own XXXX of capital (XXXXXXX,2014).
XXXXXXXXXXX Considerations
XXX J.X XXXXXXX XXXXXXX XXX XXXX XX XXXXXXXXXXX XX an alternative comparable XXXXXXX XXX estimating XXX XXXX XX XXXXXXX XX XXXXX XXXXX. XXX resulted outcome XX XXXXXXXX XXXXXXX cost XX XXXXXXX of these additional XXXXXXXXXXXXXX XXX compare with XXX above calculated weighted average cost XX XXXXXXX of XXXXX XXXXXXXXXX XXXXX XXX in XXXX XX XXXXXXX XXXXXXX a XXXXX risk XXXXXXXXXX XXXX it XXXX be a best alternative XXXXXXXXX not.
XXXXXXXXXX Cost XX XXXXXX: XXX total XXXX XXXXX XX equity XX XXXXXXX is calculated as$7.X billion. Based on a XXXXX price XX $XXX as XXXX as XXXXXX XXXXXXXXXXX of XXX million. X.7% XX XXXX XX used in estimating XXXX of equity XXXXX XX published XXXX of 0.X, a market risk XXXXXXX of X.X% XXX a prevailing XXXX term Treasury bond XXXXX XX 3.1%.
Estimating Cost of XXXX: The XXXXX XXXX value of Smucker XX XXXXXXXXXX $2.2 billion XXXX XXXXXXXX $X.9 XXXXXXX long XXXX XXXX and $X.3 XXXXXXX XX XXXXX term debt. XXX XXXXXXX XXXXXXXX XXXXXXX interest XXXX XX XXXX term XXXX is X.X% while on short XXXX it XX $X.X%. Average yield XX XXXXXXXX of XXXX term XXXX XX X.5%.
Estimating Capital XXXXXXXXX XXXXXXX: Based XX debt-XX-XXXXXXX XXXXX of 15%, XXXX of XXXXXX XX 8.5%, XXXX of debt XX 4.X% XXX XXXX XX XXXXXXX XX calculated XX below:
XXXX (Smucker) = 0.XX × 4.X% × (1 − 35%) + X.XX × X.X% = X.7>#/i###
XXX calculated WACC of XXXXXXX shows is lower XX XXXXXXX to the rates already estimated XXX XXXXX XXXXXXXXXX firms XXXX XX XXXXX XXXXX, White Oak XXX Sugarloaf XXXXXXXX.
XXXXXXXXXX
XXXX all XXXXXXX the higher risk associated with XXXX's XXXXXXXXXX. Investors XXXX XX require an additional XXXXXX XX XXXXXXXXXX this additional XXXX. WACC XX 7.X% XX these XXXXXXXXXXX XXXXXXXXXXXXXX XXXXXXXX XXXXXXXXXX XX XXXXX XXX estimated project cost of XXXXXXX that is X.X% on how XXXXXXXXXX XXXX XXXXXXXX Smucker XX XX XX XXX XXXX XX the proposed XXXXXXX. XXXXXXXXX, it is XXXXXXXXXXX XX use XXX WACC XX XXXXX calculated three comparable XXXXX so XXXX there can XX XXXXXXXX XXXXXXX rate XX return XX %7.8 XX XXXXX XXXXX XXXXX XXXXXXXX XXXXX XXX XXX debt XXXXXXXXX as well as XXXXXX XXXXXXXXX. By XXXXXXXX, XX the XXXX's return is XXXX XXXX XXX XXXX, the firm XX shedding XXXXX, indicating XXXX it's an XXXXXXXXXXX XXXXXXXXXX (XXXXXXX,XXXX).
XXXXXXX,S. (2014). The Cost XX Capital- XXXXXXXXXX and Practice. Darden XXXXXXXXXX Business.
XXXXXX,X., & Head,X. (2016).XXXXXXXXX Finance: XXXXXXXXXX and XXXXXXXX. XXXXXX, England: XXXXXXX.