Problem:
Vale is the second largest mining company based in Brazil. Although it has recently expanded its operations in Africa, Asia, Latin America, it has not yet entered the North American market. Vale is considering investments in Minnesota, Wisconsin, and Utah through a wholly owned subsidiary. It has approached two different investment banking advisors, JP Morgan and Morgan Stanley, for estimates of what its costs of capital would be several years into the future when it plans to list its American subsidiary on the U.S. stock exchange. Using the following assumptions by the two different advisors, calculate the prospective costs of debt, equity, and WACC for Vale U.S.
| Assumptions |
|
JP Morgan |
Morgan Stanley |
| Components of beta: |
Β |
|
|
| Estimate of correlation between security and market |
ρjm |
0.75 |
0.80 |
| Estimate of standard deviation of Vale's returns |
σj |
40.00% |
35.00% |
| Estimate of standard deviation of market's return |
σm |
15.00% |
18.00% |
| Risk-free rate of interest |
krf |
2.00% |
2.00% |
| Estimate of Vale's cost of debt in US market |
kd |
9.00% |
10.00% |
| EMRP (Rm-Rf) |
EMRP |
5.50% |
5.00% |
| Corporate tax rate |
T |
35.00% |
35.00% |
| Proportion of debt |
D/V |
35% |
40% |
| Proportion of equity |
E/V |
65% |
60% |