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BUS 302 Case – Cost of Capital for Renegade Cars – Assessment Questions and Answers
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In its relatively new treasury management department, you have recently been hired by Renegade Cars, Inc. (RCI). RCI was founded seven years ago by Bobby Renegade. Bobby found a method to manufacture a cheaper battery that would hold a larger charge, giving a car powered by the battery a range of 950 miles before requiring a recharge. The cars manufactured by RCI are midsized and carry a price that allows the company to compete with other mainstream auto manufacturers. Bobby and her family privately own the company, and it had sales of $197 million last year.
RCI primarily sells to customers who buy the cars online, although it does have a limited number of company-owned dealerships. The customer selects any customization and makes a deposit of 20 percent of the purchase price. After the order is taken, the car is made to order, typically within 45 days. RCI’s growth to date has come from its profits. When the company had sufficient capital, it would expand production. Relatively little formal analysis has been used in its capital budgeting process. Bobby 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 Rachel 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. Bobby wants you to use the pure play approach to estimate the cost of capital for RCI, and she has chosen Tesla Motors as a representative company. The following questions will lead you through the steps to calculate this estimate.
QUESTIONS
- 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, These corporate filings are available on the SEC website at www.sec.gov. Go to the SEC website, follow the “Search EDGAR for Company Filings” link, and search for SEC filings made by Tesla Motors (TSLA). 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.
- To estimate the cost of equity for TSLA, go to yahoo.com and enter the ticker symbol TSLA. Follow the links to answer the following questions: What is the most recent stock price listed for TSLA? What is the market value of equity or market capitalization? How many shares of stock does TSLA have outstanding? What is the most recent annual dividend? Can you use the dividend discount model in this case? What is the beta for TSLA? Now go back to finance.yahoo.com and follow the “Bonds” link. What is the yield on three-month Treasury bills? Using the historical market risk premium, what is the cost of equity for TSLA using CAPM?
- You now need to calculate the cost of debt for TSLA. Go to finra- morningstar.com/BondCenter/, enter TSLA as the company and find the yield to maturity for each of TSLA’s bonds. What is the weighted average cost of debt for TSLA using the book value weights and using 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 Calculate this using book value weights and market value weights, assuming TSLA has a 35 percent marginal tax rate. Which number is more relevant?
- You used TSLA as a pure-play company to estimate the cost of capital for RCI. Are there any potential problems with this approach in this situation? Discuss the pros and cons of the pure play approach. If you were advising RCI, is this the method you would use to evaluate new projects? What additional suggestions and comments would you have for the Board of Directors when calculating the cost of capital? Provide your response in memo format. Use complete sentences, proper grammar and spelling. You are a consultant for RCI and want to retain their Make sure your memo is work you are proud of and would encourage RCI to continue their relationship with your consulting firm.
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