Discuss the below:
Q1: Kashmiri's Cost of Capital
Kashmiri is the largest and most successful specialty goods company based in Bangalore, India. It has not entered the North American marketplace yet, but is considering establishing both manufacturing and distribution facilities in the United States through a wholly owned subsidiary. It has approached two different investment banking advisors, Goldman Sachs and Bank of New York, for estimates of what its costs of capital would be several years into the future when it planned to list its American subsidiary on a U.S. stock exchange. Using the following assumptions by the two different advisors, calculate the prospective costs of debt, equity, and the WACC for Kashmiri (U.S.),
| Assumptions |
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Symbol |
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Goldman Sachs |
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Bank of New York |
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| Components of beta: |
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β |
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| Estimate of correlation between security and market |
ρjm |
|
0.90 |
|
0.85 |
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| Estimate of standard deviation of Kashmiri's returns |
σj |
|
24.0% |
|
30.0% |
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| Estimate of standard deviation of market's return |
σm |
|
18.0% |
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22.0% |
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| Risk-free rate of interest |
|
krf |
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3.0% |
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3.0% |
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| Estimate of Kashmiri's cost of debt in US market |
kd |
|
7.5% |
|
7.8% |
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| Estimate of market return, forward-looking |
|
km |
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9.0% |
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12.0% |
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| Corporate tax rate |
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t |
|
35.0% |
|
35.0% |
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| Proportion of debt |
|
D/V |
|
35% |
|
40% |
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| Proportion of equity |
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E/V |
|
65% |
|
60% |
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| Estimating Costs of Capital |
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| Estimated beta |
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| β = ( ρjm x σj ) / ( σm ) |
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β |
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| Estimated cost of equity |
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| ke = krf + (km - krf) β |
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ke |
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| Estimated cost of debt |
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| kd ( 1 - t ) |
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kd (1-t) |
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| Estimated weighted average cost of capital |
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| WACC = (ke x E/V) + ( (kd x (1-t)) x D/V) |
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WACC |
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Q2: Ganado's Cost of Capital
Market conditions have changed. Maria Gonzalez now estimates the risk-free rate to be 3.60%, the company's credit risk premium is 4.40%, the domestic beta is estimated at 1.05, the international beta at .85, and the company's capital structure is now 30% debt. All other values remain the same. For both the domestic CAPM and ICAPM, calculate:
a. Ganado's cost of equity
b. Ganado's cost of debt
c. Ganado's weighted average cost of capital
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Domestic |
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International |
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Assumptions |
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CAPM |
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ICAPM |
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Ganado's beta, β |
|
1.05 |
|
0.85 |
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Risk-free rate of interest, krf |
3.60% |
|
3.60% |
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Company credit risk premium |
|
4.40% |
|
4.40% |
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Cost of debt, before tax, kd |
8.00% |
|
8.00% |
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Corporate income tax rate, t |
35% |
|
35% |
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General return on market portfolio, km |
9.00% |
|
8.00% |
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Optimal capital structure: |
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Proportion of debt, D/V |
30% |
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30% |
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Proportion of equity, E/V |
70% |
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70% |