Using the following information and attachment answer the bottom question

Cost of debt

• The cost of debt is the effective rate that a company pays on its total debt

• It gives an idea as to the overall rate being paid by the company to use debt financing

• This measure is also useful because it gives investors an idea as to the riskiness of the company compared to others

• The higher the cost of debt, the higher the risk

Calculation:

•
The book value of debt is calculated by adding up all the debt on the
balance sheet (notes payable, current portion of LT debt and long-term
debt

Starbucks:

• Interest expense= 64,100 million (income statement)

• Total book value of debt= 5,480,900 (balance sheet)

Cost of debt= 64.100 / 5,480,900= 1.16951

Cost of preferred stock

• Preferred stock is a special equity security that has properties of both equity and debt.

• Cost of preferred stock is the rate of return required by the holders of the company’s preferred stock

Calculation:

• It is calculated by dividing the annual dividend payment of the preferred stock by the preferred stock current market price

Starbucks:

• Starbucks has a 0 preferred stock on their balance sheet

Cost of common equity

• The return that stockholders require for a company

Calculation:

• Use the capital asset pricing model (CAPM) to calculate the required rate of return

•
The formula is: cost of equity= risk-free rate of return + beta of
asset x expected return of the market – risk free rate of return

Starbucks:

• Risk-free rate= U.S. 10 year bond= 2.17 (12/31/14)

o
obtained the information from
ww.treasury.gov/resource-center/data-chart-center/interestrates/pages/textview.aspx/data=yieldyear&year=2014

• Average market return 1950 – 2013= 7% (risk free rate of return also called market premium)

o Obtained from pages.stern.nyu.edu/-adamodar/new_home_page/datafile/histretsp.html

• Beta= 0.78 (Yahoo Finance)

2.17 + 0.78 (7-2.17)

2.17 + 0.78 x 4.83

2.17 + 3.77= 5.94%

Weighted average cost of capital

•
As the WACC of a firm increases, and the beta and rate of return on
equity increases, this is an indication of a decrease in valuation and a
higher risk

• By taking the weighed average, we can see how much interest the company has to pay for every dollar it finances

Calculation:

• WACC= R=(1-tax rate)x R debt (D/D+E)+ R equity (E/D+E)

• (1-tax rate) x R debt (D/D+E) + R equity (E/D+E)

Starbucks:

• Tax rate= 32.02% in 2014 (average of 4 qtrs)

• Cost of debt (before tax) or R debt= 3.83%

• Debt (total liabilities for 2014)= 5,480,900 (balance sheet)

• Debt of equity or D+E 2014= 5,480,900 + 5,272,00= 10,752,900

• Cost of equity or R equity= 5.94%

• Equity= stock price x outstanding shares or e= (shares outstanding 1.50B x 52.63 stock price)= 78.945 billion

(1-.3202) x .0383 x (5.481 / 10.753) + .0594 ($78.945 / 10.753)

.6798 x .0383 x .051 + .0894 x 7.342

.0013 + .4361= 0.437

Answer with Excel Question

You will use the WACC as the discount rate to conduct capital budgeting analysis for a project that the

firm is considering and then decide whether it should be accepted or not which is “ Building a new

Building” for $1 million. If you do not have a number you need, research it and state your assumptions

that you used to get the missing number.