Cost of capital

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Cost of capital Exercises with solutions Accounting, Finance & Control 2018-2019 Accounting, Finance & Control 2018-2019 2 Table 1 – to be used for the following exercises Source: bloomberg.com 1 Cost of capital You are a financial analyst and your clients (who are financial investors) asked you to estimate the cost of capital (WACC) of Andromeda, a manufacturing company producing and exporting its products only in Europe. Reading the company reports you get to know that Andromeda has 700 mln € financial debts bearing an annual interest rate of 7.5%. The market capitalization (i.e. equity) of the company is 350 mln € and the corporate tax rate is 35%. Luckily you also have a trustworthy estimation of the equity beta (i.e. beta levered) equal to 1.2. You are committed to do a reliable estimation of the cost of capital of Andromeda and, therefore, you read the latest financial market data on government bonds (10Y Government B onds) in Table 1. Finally, you find estimations about the expected returns on the main market indexes. In particular, the expected return on Euro Stoxx is 15% while FTSE MIB is forecasted at 20%. • Compute Andromeda’s WACC 1.1 Solution k e = 0.78% + 1.2 × (15% − 0.78%) = 17.84% WACC = 700 (700 + 350) × 7.5% × (1 − 35%) + 350 (700 + 350) × 17.84% = 9.20% Accounting, Finance & Control 2018-2019 3 2 Cost of capital Your clients are satisfied with your estimations of Andromeda but now they ask you to estimate the cost of capital of another manufacturing company, Carlton. Carlton has financi al debts valued 880 mln € and a financial leverage (D/E) equal to 2.2. The annual interest rate on debt is 8% and tax rate is 36%. Unluckily, Carlton is not listed and, therefore, you have to estimate Beta by yourself. As such, you decide to find out some comparable…