Question: Purpose of Assignment: Students should understand the mechanics in calculating a company's weighted average cost of capital using the capital asset pricing model (CAPM) and its use in making financial investments.
Scenario: You work for an investment banking firm and have been asked by management of Vestor Corporation (not real), a software development company, to calculate its weighted average cost of capital, to use in evaluating a new company investment. The firm is considering a new investment in a warehousing facility, which it believes will generate an internal rate of return of 11.5%. The market value of Vestor's capital structure is as follows:
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Source of Capital
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Market Value
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Bonds
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$10,000,000
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Preferred Stock
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$2,000,000
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Common Stock
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$8,000,000
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To finance the investment, Vestor has issued 20 year bonds with a $1,000 par value, 6% coupon rate and at a market price of $950. Preferred stock paying a $2.50 annual dividend was sold for $25 per share. Common stock of Vestor is currently selling for $50 per share and has a Beta of 1.2. The firm's tax rate is 34%. The expected market return of the S&P 500 is 13% and the 10-Year Treasury note is currently yielding 3.5%.
The discount rate Vestor should use to evaluate the warehousing project is 9.18%.
Assess whether Vestor should make the warehouse investment. Prepare the analysis of the project and the decision to be made (approx. 400 words).
Format your assignment consistent with APA guidelines. As always make sure you provide references and let us know where you are using them. Also see attachment with Instructor Notes.