Hubbard Computer, Inc. (HCI) has recently hired you in its relatively new treasury management department. HCI was founded eight years ago by Bob Hubbard and currently operates 74 stores in the Southeast. HCI is privately owned by Bob and his family, and had sales of $97 million last year. HCI primarily sells to in-store customers who come to the store and talk with a sales representative. The sales representative assists the customer in determining the type of computer and peripherals that are necessary for the individual customer’s computing needs. After the order is taken, the customer pays for the order immediately, and the computer is made to fill the order. Delivery of the computer averages 15 days, and it is guaranteed in 30 days.
HCI’s growth to date has been financed by its profits. When the company had sufficient capital, it would open a new store. Other than scouting locations, relatively little formal analysis has been used in its capital budgeting process. Bob 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 Bob would like you to perform the analysis. Since the company is privately owned, it is difficult to determine the cost of equity for the company. Bob wants you to use the pure play approach to estimating the cost of capital for HCI, and he has chosen Dell as a representative company. The following steps will allow you to calculate this estimate.
- Most publicly traded corporations are required to submit quarterly (10Q) and annual reports (10K) to the SEC detailing the financial operations of the company over the past quarter or year, respectively. These corporate filings are available on the SEC website at www.sec.gov. Go to the SEC website and search for SEC filings made by Dell. Find the most recent 10Q or 10K and download the form. Look on the balance sheet to find the book value of debt and the book value of equity. If you look further down the report, you should find a section titled “Long-term Debt and Interest Rate Risk Management” that will provide a breakdown of Dell’s long-term debt.
- To estimate the cost of equity for Dell, go to finance.yahoo.com and enter the ticker symbol DELL. Follow the various links to answer the following questions: What is the most recent stock price listed for Dell? What is the market value of equity, or market capitalization? How many shares of stock does Dell have outstanding? What is the most recent annual dividend? Can you use the dividend discount model in this case? What is the beta for Dell? Now go back to finance.yahoo.com and find the “Bonds” link. What is the yield on 3-month Treasury bills? Using the historical market risk premium, what is the cost of equity for Dell using the CAPM?
- You now need to calculate the cost of debt for Dell. Go to www.nasdbondinfo.com, enter Dell as the company and find the yield to maturity for each of Dell’s bonds. What is the weighted aver-age cost of debt for Dell using the book value weights and the market value weights? Does it make a difference in this case if you use book value weights or market value weights?
- You now have all the necessary information to calculate the weighted average cost of capital for Dell. Calculate the weighted average cost of cap-ital for Dell using book value weights and market value weights. Assume Dell has a 35 percent marginal tax rate. Which cost of capital number is more relevant?
- You used Dell as a pure play company to estimate the cost of capital for HCI. Are there any potential problems with this approach in this situation?
4. What was the largest IPO? Go to www.hoovers.com and find out. In what country was the company located? What was the largest IPO in the United States?
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