Finance case study

Finance case study

Case Study: Cost of Capital for Swan Motors (Due June 20)

You have recently been hired by Swan Motors, Inc. (SMI), in its relatively new treasury

management department. SMI was founded 8 years ago by Joe Swan. The cars manufactured by SMI are

midsized and carry a price that allows the company to compete with other mainstream auto manufacturers.

The company is privately owned by Joe and his family, and it had sales of $97 million last year.

When the company had sufficient capital, it would expand production. Relatively little formal

analysis has been used in its capital budgeting process. Joe has just read about capital budgeting techniques

and has come to you for help. For starters, the company has never attempted to determine its cost of capital,

and Joe would like you to perform the analysis. Because the company is privately owned, it is difficult to

determine the cost of equity for the company. Therefore, Joe wants you to use the pure play approach (an

approach used to estimate the cost of capital of private companies, which involves examining other public

and single focused companies) to estimate the cost of capital for SMI, and he has chosen Tesla Motors as

a representative company. The following questions will lead you through the steps to calculate this

estimate.

1. Most publicly traded corporations are required to submit 10K (annual) reports to the SEC detailing

their financial operations over the previous year. These corporate filings are available on the SEC

website at www.sec.gov. Go to the SEC website, follow the “Search for Company Filings” link and

the “Companies & Other Filers” link, enter “Tesla,” and search for SEC filings made by Tesla. Find

the most recent 10K and download the form. Look on the balance sheet to find the value of equity. If

you look further down the report, you should find a section titled “Convertible and Long-Term Debt

Obligations” that will list a breakdown of Tesla’s long-term debt.

2. To estimate the cost of equity for Tesla, go to finance.yahoo.com and ether the ticker symbol “TSLA.”

What is the beta for Tesla? Now go back to finance.yahoo.com and follow the “Markets” and “US

Treasury Bonds Rates” link. What is the yield on 13-week Treasury bills (last price)? Using a 7 percent

market risk premium, what is the cost of equity for Tesla using the CAPM?

3. You need to calculate the cost of debt for Tesla. Go to finra-markets.morningstar.com/BondCenter/

and enter Tesla as the company, and find the yield to maturity for each of Tesla’s bonds. Using only

the yields that are available and before the maturity, what is the weighted average cost of debt for

Tesla using the book value (Unpaid Principal Balance) weights from 10K “Convertible and Long-

Term Debt Obligations” section?

4. You now have all the necessary information to calculate the weighted average cost of capital for Tesla.

Calculate the weighted average cost of capital for Tesla using book value weights (book values from

the 10K balance sheet and “Convertible and Long-Term Debt Obligations”) assuming Tesla has a 35 percent marginal tax rate.

Solution Preview
  1. Using the data gathered for Tesla, the Beta value for the company (β) is 0.91.

The information available on Yahoo! Finance on the 13-week Treasury Bills last price gave a value of Rf 1.898.

  1. Cost of Equity for Tesla using the CAPM

To calculate this, we need the risk free rate Rf, the market risk premium (Rm – Rf) and the stock beta (β). The formula is as follows:

CAPM: Rs =Rf + β * (Rm – Rf)

Therefore Rs = 1.898 + 0.91 * 7% … = 1.898+ 6.37 = 8.268% (CAPM)

  1. Cost of Debt for Tesla

This is the interest required on a new debt issue, in other words, the yield to maturity on outstanding debt.

(401 words)
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