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(Eq. 13.2)
Assume DuPonts class A preferred stock has a price of $66.67 and an annual dividend of $3.50. Its cost of preferred stock, therefore, is $3.50 $66.67 = 5.25%
(Eq. 13.5)
Cost of Equity =
For
a
company
that
does
not
have
preferred
stock,
the
WACC
condenses
to:
rwacc
=
rEE%
+
rD(1
-
TC)D%
(Eq. 13.7)
rWACC
! Market Value of Equity " ! " Net Debt = rE $ % + rD (1 TC ) $ % Enterprise Value Enterprise Value ' & ' &
Table 13.2 Historical Excess Returns of the S&P 500 Compared to One-Year Treasury Bills and Ten-Year U.S. Treasury SecuriWes
V0L = FCF0 +
Table 13.3 Expected Free Cash Flow from DuPonts Facility Project
To get Danones WACC, we use equaWon 13.6. Danone has no preferred stock, so the WACC is:
Thus, the firm's asset beta is a weighted average of the debt and equity betas. The assumption that Debt = 0 is often made: Equity Debt + Equity
Assets = Equity
Assets = Equity
Debt Equity = Assets + Assets Equity What does this equation say about where equity risk comes from?
Your company has two divisions. One sells beverages and the other manufactures and sells fancy candy bars through a direct retail channel You feel that Rocky Mountain Chocolate Factory is a comparable publicly traded company for your candy bars division. If RMCFs beta for its common stock is 0.96 and its debt is 10% of its capital structure What is the appropriate discount rate for projects in your candy bar division? Assume a risk free rate of 3% and a risk premium (market return minus risk free rate) of 8%
Solution
We can use RMCFs Beta of equity to solve for RMCFs Beta of Assets to obtain a measure of the project risk of your division:
Assets
Equity = Equity Debt + Equity